SID - Slovenska izvozna in razvojna banka, d.d., Ljubljana •S)DBanka ANNUAL REPORT 2006 Company name: SID - Slovenska izvozna in razvojna banka, d.d., Ljubljana SID - Slovene Export and Development Bank, Inc., Ljubljana Ulica Josipine Turnograjske 6, SI-1000 Ljubljana, Slovenia Address: ID Number: VAT Identification Number: 5665493 SI 82155135 Telephone: Management 01/ 200 75 00 01/ 200 75 53 Board: Telefax: E-mail: Website: 01/ 200 75 75 info@sid.si http://www.sid.si Companies of the SID Bank Group SID - Prva kreditna zavarovalnica d.d., Ljubljana Ulica Josipine Turnograjske 6, SI-1000 Ljubljana, Slovenia tel.: +386 1 200 58 00; fax: +386 1 425 84 45 http://www.sid-pkz.si PRO KOLEKT, družba za izterjavo, d.o.o. Ulica Josipine Turnograjske 6, SI-1000 Ljubljana, Slovenia tel.: +386 1 200 75 90; fax: +386 1 421 06 21 http://www.prokolekt.si PRO KOLEKT d.o.o., Savska cesta 41, 10144 Zagreb, Hrvaška tel.: +385 1 617 70 08, fax: +385 1 617 72 16 http://www.prokolekt.hr PRO KOLEKT d.o.o. Bulevar Goce Delcev 11, 1000 Skopje, Macedonia Tel./fax: +389 2 312 18 13 PRO KOLEKT d.o.o., Zmaj Jovina 13/I, 11000 Belgrade, Serbia tel.: +381 11 303 87 96; fax: +381 11 303 87 97 PRVI FAKTOR, faktoring družba, d.o.o., Slovenska cesta 17, SI-1000 Ljubljana; Tel.: +386 1 200 54 10; fax: +386 1 200 54 20 http://www.prvifaktor.si PRVI FAKTOR, faktoring društvo, d.o.o., Hektoroviceva 2/V, 10000 Zagreb, Croatia tel.: : +385 1 617 78 05; fax: +385 1 617 66 29 http://www.prvifaktor.hr PRVI FAKTOR - faktoring d.o.o., Cara Dušana 43/1, 11000 Belgrade, Serbia tel.: + 381 11 334 33 12; fax: + 381 11 334 30 32 http://www.prvifaktor.co.yu PRVI FAKTOR d.o.o., finansijski inžinjering, Zmaja od Bosne 14 c /I, 71000 Sarajevo, Bosnia and Herzegovina tel.: + 387 33 612 087; fax: + 387 33 612 088 http://www.prvifaktor.ba CONTENTS I. BUSINESS REPORT Statement by the President of the Board 2 Statement by the Supervisory Board 4 1. Highlights from the Business Operations of 2006 5 2. Corporate Profile of SID Bank 7 3. SID Bank Group 10 4. International Economic Environment and Slovene Economy 12 5. Development Strategy of SID Bank 16 6. Review of SID Bank Operations in 2006 17 6.1. Financial Review of SID Bank Operations 17 6.2. Financing of International Business Transactions 19 6.3. Borrowing 23 6.4. Treasury 24 6.5. Operations on Special Authorisation - Insurance against Non-marketable Risks 26 6.6. Operations on Special Authorisation - Interest Rate Equalization Programme (IREP) 30 6.7. Credit Rating and Other Credit Information 31 6.8. Risk Management 32 6.9. Information System 37 6.10. Personnel 38 6.11. Internal Audit 40 7. Review of SID Bank Group Operations in 2006 41 7.1. Financial Review of SID Bank Group Operations 41 7.2. SID - Prva kreditna zavarovalnica d.d., Ljubljana 42 7.3. PRO KOLEKT Group 43 7.4. PRVI FAKTOR Group 43 8. Appendices 44 8.1. Management Bodies of SID Bank as at 31 December 2006 44 8.2. Organisation Chart of SID Bank as at 31 December 2006 45 II. FINANCIAL STATEMENTS OF SID BANK 46 III. CONSOLIDATED FINANCIAL STATEMENTS OF THE SID BANK GROUP 93 SID bank - Annual Report 2006 1 Statement by the President of the Board Dear Ladies and Gentlemen, The year 2006 was probably the most eventful and challenging business year in the short history of the company. It was marked by at least three important events: - transformation of SID into SID Bank, - creation of new company strategy and - introduction of the Euro and the International Financial Reporting Standards. As the nature of these events required considerable effort and patience from SID Bank employees, clients and shareholders alike, we can proudly say that the year 2006 was an exceptional year both in terms of organisational and technical aspects and with regard to business operations. The good business results achieved in 2006 resulted from above-average involvement of employees and shareholders who supported our efforts to transform into a bank and who offered their support to our new business strategy. Although demanding, the changes seem to have had a desirable impact on the business operations of SID Bank in all spheres of its activity to accommodate anticipated growth or even reach beyond it. In financing international business transactions, which SID Bank conducts on its own behalf and for own account, volume of business was up 23.9%, climbing to SIT 181 billion (EUR 757 million) at the end of the year. In part, the growth was driven by borrowings in international financial markets, which SID Bank took out on own behalf and for own account with the guarantee of the Republic of Slovenia and secured with a successful issue of debt certificates (Schuldscheins) under very favourable conditions. In short-term and medium-term export credit insurance against non-commercial risks and in investment insurance, which SID Bank performs on behalf and for the account of the Republic of Slovenia, the total volume of business insured increased by 3% to SIT 96 billion (EUR 402 million), with net exposure rising by 13% to SIT 115 billion (482 million). Growth was highest for medium-term export credit insurance. In addition, SID Bank performed well in the related management of contingency reserves, which went up 6% to SIT 23.4 billion (EUR 97.8 million) in 2006 and which are, from a public finance point of view, proof of high security of business operations conducted on behalf and for the account of the Republic of Slovenia. The Bank was also successful in providing other complementary activities such as issuance of guarantees, provision of credit rating and other credit information, business and legal counselling and performance of other operations conducted under mandate. In June 2006 SID Bank hosted the Annual Meeting of the ISLTC Club, which is a union of 25 members, most of them public finance institutions or banks specialized in long-term financing. The Meeting contributed to the professional exchange of ideas and insights on the future operation of these financial subjects, all of great importance for the European market. Through its activities of providing funding to banks, exporters, Slovene investors and foreign buyers and by providing short-term and medium-term export credit insurance, SID Bank actively promoted the international economic cooperation of Slovenia, in particular development of Slovene economic entities, and contributed to the stability and growth of international economic environment, trade, investment and development. Accordingly, total assets were up 28% in 2006 totalling SIT 193.3 billion (EUR 806.5 million) at the end of the year. Total assets plus contingency reserve and Interest Rate Equalization Programme (IREP) amounted to SIT 218.2 billion (EUR 910.6 million). The good business results achieved in 2006 were also reflected in pre-tax profit amounting to SIT 830 million (EUR 3.5 million) although the annual figure fell behind the 2005 level due to changes in valuations and amount of provisions. Apart from achieving business results, the activities of SID Bank in 2006 were focused on organisational and technical changes as part of the process of transition to banking operations, which caused considerable changes to the organisation structure of the company and the efficiency of its operations. Special mention needs to be made of the newly established Risk Management department, reorganisation of the IT department through implementation of an effective information security management system, and the restructured Back Office, all with a view to ensure effective banking operations and reporting to supervisors in accordance with good banking practice. Annual Report SID Bank - 2006 2 On 24 October 2006 Slovenska izvozna družba, d.d., Ljubljana obtained from the Bank of Slovenia a licence to provide banking and other financial services, and in January 2007 the company formally started operating as a bank. Throughout 2006, SID operations were subject to dynamic development and kept up to date with the trends in the wider economic environment. In 2006 the economic environment in Slovenia was characterized by high (5.2%) economic growth, fast growth of imports and exports (over 10%) and changes linked to the introduction of the Euro and the related convergence to the EMU (inflation, interest rates, etc.) in the Slovene financial market. In 2006 European economy grew at a favourable annual rate of 2.8%, and the upward trend in world economy was preserved, leading to a positive development of international cooperation, trade and development. In its operations SID Bank responded to the domestic and international development trends by modifying some of its products and by introducing several new products and services in accordance with the newly adopted corporate strategy and introduction of the Euro. The subsidiaries of the SID Bank Group followed the lead of its parent company in responding to the challenges of their economic environments. SID - Prva kreditna zavarovalnica (PKZ), established in 2005, closed the year with 20% growth which led to the volume of business insured amounting to SIT 890 billion (EUR 3.7 billion) and net profit climbing to SIT 450 million (EUR 1.9 million). Through its activities, PKZ made a decisive contribution to the management of credit portfolio of Slovene companies in the domestic and foreign markets. PRO KOLEKT, another SID Bank subsidiary, performed debt collection services and intermediation of transactions and credit rating information for Slovene companies mostly in South Eastern Europe. With a view to achieving this aim, PRO KOLEKT established its subsidiaries in Zagreb, Skopje and Belgrade in 2006. The highest growth in the SID Bank Group was recorded by SID subsidiary PRVI FAKTOR or the PRVI FAKTOR Group. In the markets of South Eastern Europe the company recorded annual growth of over 200%. In this way, the company has contributed to the promotion of factoring and purchase of receivables in this environment and established very good business results. Adoption of the new strategy and strategic orientations of SID Bank was one of the most important tasks in 2006 aimed at profiling the new specialized bank in the Slovene economic and financial environment and at defining its business model. The vision and mission of SID Bank are based on its continued development into a national export credit and development bank, which will maintain its role of the national export credit agency and, by performing a complementary activity, the role of a national development financial institution. In the future, various finance services will be provided to Slovene economic entities by one financial institution -the SID Bank Group, as a one-stop shop. The SID Bank's new role of providing services that are subsidiary and complementary to the financial market with regard to managing specific, mainly non-commercial or non-marketable risks, is aimed at creating new value added for both the Bank's clients and shareholders. We are working towards this objective through partnerships with other Slovene banks and other institutions in the Slovene and international financial markets, constantly striving to promote innovation, competitiveness and internationalization of Slovene economy. SID Bank will continue to act in line with the interests of our clients, shareholders and employees and the wider European economic and financial environment as well as sustainable development of Slovenia, by mitigating risks and increasing the opportunities for growth and development. Like in the past, we look forward to your and our future challenges arising in the Slovene and international business environment. Presidenf of the Boand Annual Report SID Bank - 2006 3 Statement by the Supervisory Board In 2006 the Supervisory Board of SID Banka, d.d., Ljubljana maintained a constant watching brief on the course of business and the situation of the company with regard to its goals and strategic orientations and in compliance with the Rules of Procedure of the Supervisory Board, the Articles of Association of SID Bank and in line with the regulations stating the authorities of the Supervisory Board. The Supervisory Board of SID Bank met at eight regular and six correspondence meetings where it studied periodical reports on the operations of the bank and the companies of the SID Bank Group, quarterly internal audit reports, data on risk management and other general and specific issues related to the business operations of the company. Throughout 2006 the Supervisory Board closely monitored the project aimed at harmonising the business operations of the company with the regulations governing operations of banks pursuant to the Act Governing Insurance and Financing of International Business Transactions and paid special attention to the establishment of SID - Slovenska izvozna in razvojna banka (SID - Slovene Export and Development Bank) and appointment of the Management Board of the new bank. In 2006 the Supervisory Board discussed and decided on the following important issues: - Action Strategy for the period 2006-2010, - proposed changes to the Articles of Association, - business policy and business plan for the year 2007, - working plan of internal audit for the year 2007, - current status and development of IT systems, - borrowings in international financial markets, - introduction of the Euro. In monitoring and supervising the business operations of the company, the Supervisory Board obtained all the information necessary for continuous evaluation of the obtained results and of the performance of the Management Board, and adopted decisions within its powers. At its meeting held on 25 May 2007, the Supervisory Board examined in detail the Annual Report for 2006 together with the reports of the certified auditor prepared by the auditing house Deloitte revizija d.o.o., which gave a positive opinion on the consolidated financial statements of the SID Bank Group for the year 2006. Upon examining all the submitted reports, the Supervisory Board found that in 2006 the company followed its planned policy and achieved its set business goals. Therefore, the Supervisory Board has no reservations to the submitted reports and hereby confirms the Annual Annual Report of SID banka, d.d., Ljubljana for the year 2006. Annual Report SID Bank - 2006 4 1. Highlights from the Business Operations of 2006 The year 2006 saw completion of the transformation of Slovene Export Corporation, Export Insurance and Finance Corporation of Slovenia, Inc. Ljubljana, into a bank, as required by the Act Governing Insurance and Financing of International Business Transactions (hereinafter ZZFMGP). Although the transformation process was very demanding, SID performed well against the goals set for the year. On 24 October 2006 Slovenska izvozna družba, d.d., Ljubljana obtained from the Bank of Slovenia a licence to provide banking and other financial services. Upon the entry into the Register of Companies on 29 December 2006, the company was renamed as SID - Slovene Export and Development Bank, Inc., Ljubljana (short name: SID Bank, Inc., Ljubljana) and on 1 January 2007 started operating as a bank. In the continuation of this Annual Report, regardless of the time of operation and the change of company name, SID Bank, Inc., Ljubljana and prior to 29 December 2006 Slovene Export Corporation, Inc. Ljubljana are referred to as SID or SID Bank, whereas all capital-linked SID companies are referred to as the SID Group or the SID Bank Group. As Slovenia adopted the euro as its single currency in 2007, the figures in this Business Report are given in SIT and in EUR.* Business results of SID Bank in 2006 or as at 31 December 2006 Business results from insurance on own account • Financing of international business transactions - SIT 181.4 billion (EUR 757.0 million) (up by 23.9%) • Value of guarantees issued - SIT 8.6 billion (EUR 36.0 million) (down by 23.2%) • Total assets - SIT 193.3 billion (EUR 806.5 million) (up by 28.2%) • Total assets including contingency reserve and IREP - SIT 218.2 billion (EUR 910.6 million) (up by 26.1%) • Net profit - SIT 612.8 million (EUR 2.6 million) (down by 67.8%) Business volume and results from insurance on behalf and for the account of the Republic of Slovenia • Export credit and investment insurance against non-marketable risks on behalf of and for the account of the state - SIT 96.4 billion (EUR 402.2 million) (an increase of 3.5%), broken down into short term export credit insurance SIT 1.5 billion (EUR 6.3 million) (down by 10.6%), medium term export credit insurance SIT 21.3 billion (EUR 88.9 million) (up by 30.3%) and outward investment SIT 73.6 billion (EUR 307.1 million) (down by 2.1%). • Premiums SIT 1.6 billion (EUR 6.7 million) (up by 4.7%) / claims SIT 238.1 million (EUR 1.0 million) (down by 69.4%) • Contingency reserve - SIT 23.4 billion (EUR 97.8 million) (up by 5.8%) Key figures 2002 2003 2004 2005* 2006* Number of shareholders 89 89 88 87 87 Nominal capital (in SIT million) 9,323.5 9,323.5 9,323.5 9,323.5 9,323.5 Nominal capital (in EUR million) 40.5 39.4 38.9 38.9 38.9 Equity (in SIT million) 18,236.9 18,515.5 19,046.0 24,744.1 25,017.9 Equity (in EUR million) 79.2 78.2 79.4 103.3 104.4 Net profit (in SIT million) 237.3 278.5 617.2 1,903.0 612.8 Net profit (in EUR million) 1.0 1.2 2.6 7.9 2.6 Return on equity after tax (ROE) 1.31% 1.52% 3.29% 7.99% 2.45% Number of employees (31 Dec.) 69 74 83 62 68 ** Data stated are taken from financial statements prepared in accordance with the International Financial Reporting Standards. * Note: Unless otherwise specified, SIT (Slovene Tolars) equivalents in EUR used for showing SID business results at the end of each calendar year correspond to the middle (final monthly) exchange rates of the Bank of Slovenia on the last day of each calendar year. Thus the following exchange rates were used for expressing the data in EUR: 31.12.2002: 1 EUR = 230.2673 SIT; 31.12.2003: 1 EUR = 236.6903, 31.12.2004: 1 EUR = 239.7430; 31.12.2005: 1 EUR = 239.5756, 31.12.2006: 1 EUR = 239.6400 SIT). For other operational figures the values expressed in EUR were calculated from the average monthly exchange rates of the Bank of Slovenia in a given calendar year (2002: 226.2237 SIT; 2003: 233.7045 SIT; 2004: 238.8615, 2005: 239.6371, 2006:239.6013). Annual Report SID Bank - 2006 5 Business results of companies of the SID Bank Group in 2006 (as at 31 December 2006) SID - Prva kreditna zavarovalnica d.d., Ljubljana • Wholly-owned by SID Bank, nominal capital - SIT 2,020.3 million (EUR 8.4 million) (up by 25.0%); • Business volume including domestic and export credit insurance against marketable risks - SIT 898.5 billion (EUR 3,750 million) (up by 23.5%); • Total assets - SIT 6,943.1 million (EUR 29.0 million) (up by 2.2%); • Net profit - SIT 450.1 million (EUR 1.9 million) (down by 14.5%). PRO KOLEKT, družba za izterjavo, d.o.o. • Wholly-owned by SID Bank, nominal capital - SIT 3.1 million (EUR 12.8 thousand) (up by 32.0%); • Value of assumed collection cases - SIT 3,474.2 million (EUR 14.5 million) (up by 44.4%); • Total assets - SIT 28.9 million (EUR 120.8 thousand) (up by 45.5%); • Loss - SIT 4.0 million (EUR 16.9 thousand) (in 2005, net profit amounted to SIT 133 thousand or EUR 0.6 thousand). PRVI FAKTOR, faktoring družba, d.o.o. • Fifty percent owned by SID Bank, nominal capital - SIT 797.8 million (EUR 3.3 million) (down by 13.1%); PRVI FAKTOR Group - SIT 1,415.7 million (EUR 5.9 million) (up by 54.9%); • Value of acquired receivables - SIT 44.1 billion (EUR 184.0 million) (up by 72.9%); PRVI FAKTOR Group SIT 119.9 billion (EUR 500.4 million) (up by 136.7%); • Total assets - SIT 16,846.7 million (EUR 70.3 million) (up by 47.3%); PRVI FAKTOR Group - SIT 51,792.9 million (EUR 216.1 million) (up by 123.3%); • Net profit - SIT 44.2 million (EUR 0.2 million) (down by 15.3%); PRVI FAKTOR Group - SIT 558.5 million (EUR 2.3 million) (up by 273.1%); Consolidated financial statements of the SID Bank Group • Total assets - SIT 224.6 billion (EUR 937.3 million) (up by 34.4%); • Equity - SIT 28.7 billion (EUR 119.7 million) (up by 4.7%); • Net profit - SIT 1.6 billion (EUR 6.9 million) (down by 25.6%); • Return on equity after tax - 5.90% (8.43% in 2005). Annual Report SID Bank - 2006 6 2. Corporate Profile of SID Bank Legal status and history • Slovenska izvozna družba, družba za zavarovanje in financiranje izvoza Slovenije, d.d., Ljubljana was established on 22 October 1992 as a specialised private-law financial institution for insurance and financing of exports. In accordance with the Law establishing Slovene Export Corporation, it operated as an authorised export credit agency (ECA). • The Corporation was entered into the Register of Companies at the District Court of Ljubljana with Decision No. SRG 8096/92 of 27 October 1992, under record entry number 1/19966/00. • In accordance with the Act Governing Insurance and Financing of International Business Transactions (hereinafter ZZFMGP), which came into force on 14 February 2004, SID provides insurance against non-marketable risks and the Interest Rate Equalization Programme (IREP) in the name and on behalf of the Republic of Slovenia, and carries out financing and issue of guarantees for its own account. In this respect, the Republic of Slovenia issues guarantees to secure SID borrowings (intended to finance international transactions) to lenders and investors in SID debt securities. • Pursuant to ZZFMGP, SID signed an agreement with the Ministry of Finance on the regulation of mutual relations concerning implementation of Chapter II of ZZFMGP on 1 December 2004. • In establishing an insurance company and transferring onto it the insurance portfolio which it had performed on its own behalf by the end of 2004, SID acted in accordance with ZZFMGP, modifying its status and activities regarding these classes of insurance with the regulations governing insurance company operations. SID - Prva kreditna zavarovalnica d.d., Ljubljana, wholly-owned by SID, was entered into the Register of Companies on 31 December 2004. • In 2006 the project of transforming SID into a bank was completed as SID was bound by Article 17, paragraph six, of ZZFMGP to harmonise its operations which were not insurance operations and therefore not the subject matter of ZZFMGP with the regulations governing operation of banks by 31 December 2006 at the latest. Harmonisation was carried out in compliance with the contents and deadlines set out in the Decision on harmonisation of business operations of Slovenska izvozna družba, d.d., Ljubljana with the regulations governing operation of banks, which was issued by the Bank of Slovenia pursuant to ZZFMGP. • On 24 October 2006 SID obtained from the Bank of Slovenia a banking licence to provide banking and other financial services. • Upon the entry into the Register of Companies on 29 December 2006, the company was renamed as SID -Slovenska izvozna in razvojna banka, d.d., Ljubljana (short name: SID banka, d.d., Ljubljana) and on 1 January 2007 it formally started operating as a bank. • SID uses a two-tier management system with a Management Board and a Supervisory Board. The management and supervisory boards act in accordance with the existing legislation, the statute, corporate values and other regulations and recommendations from peer associations, and in particular with the specific role of SID evident in the activities of SID Bank. Formally, however, the company does not apply corporate management codes in its operations. • The members of the Supervisory Board are appointed by the General Meeting of Shareholders by way of an ordinary majority of the shareholders present and votes validly cast, whereas the decision for early recall of Supervisory Board members is to be approved by a three-quarter majority of shareholders present and represented. • The Management Board of SID Bank is appointed by the Supervisory Board. The Supervisory Board may also recall a member of the Management Board or a Managing Director under the conditions stated in Article 268, paragraph 2, of the Companies Act. The Management Board of SID Bank shall represent the Bank jointly. The Management Board shall obtain the consent of the Supervisory Board in all matters defined by law or the company's articles. • Amendment of the company's articles requires a decision by the General Meeting of Shareholders taken by a majority which may not be less than three quarters of the votes cast and represented. Capital as at 31 December 2006 • The nominal capital of the company is SIT 9,323.540 thousand. • The capital is divided into 932,354 ordinary nominal shares, issued in non-materialized form. The central securities register and all securities trading procedures are managed by the Central Securities Clearing Corporation in Ljubljana. • The decision to convert nominal shares (with a nominal value of SIT 10,000 per share) into unit shares was taken at the General Meeting of Shareholders on 23 May 2006. The change became effective on the day of entry of the Statute into the Court Register (26 July 2006). • After the redenomination of nominal capital in EUR (at the conversion rate), the nominal capital of the company will be EUR 38,908,443 and will be divided into 932,354 unit shares. In accordance with the decision taken by the General Meeting of Shareholders, the Supervisory Board of SID Bank is responsible for redenominating the nominal capital in EUR amounts. The redenomination shall take effect at the first Supervisory Board Meeting or at the first General Meeting of Shareholders held in the year 2007. • Equity amounted to SIT 25,017,939 thousand (EUR 104,398 thousand) as at 31 December 2006. _ 7 Annual Report SID Bank - 2006 • Audited book value per share as at 31 December 2006 was SIT 27,375 (EUR 114), an increase from SIT 26,539 (EUR 111) as at 31 December 2005. The audited book value per share was calculated from data contained in financial statements prepared in accordance with the International Financial Reporting Standards. Shareholders • As at 31 December 2006 SID had 87 shareholders. • The majority shareholder of SID Bank is the Republic of Slovenia, which holds a 91.15% share. • The voting rights of the shareholders of SID Bank are not limited, and the one share-one vote principle is applied. Financial rights attached to shares are linked to their ownership. • Ownership structure by shareholder type (as at 31 December 2006) Shareholders Ownership (in %) Republic of Slovenia 91.15% Banks 5.15% insurance companies 1.03% Chamber of Commerce and Industry of Slovenia 0.01% other companies 2.59% natural persons 0.08% Total 100.00% • Shareholders (as at 31 December 2006) Number of Shareholders shares Ownership (in %) Republic of Slovenia 849,812 91.15% SID Bank, Inc, Ljubljana 18,445 1.98% Nova ljubljanska banka d.d., Ljubljana 18,027 1.93% Komercialna banka Triglav d.d. - in bankruptcy 5,104 0.55% Lesnina Inženiring d.d., Ljubljana 4,420 0.47% SKB banka d.d. 4,246 0.46% Petrol, d.d., Ljubljana 3,940 0.42% Zavarovalnica Triglav, d.d. 3,400 0.36% Zavarovalnica Maribor d.d. 2,885 0.31% Adriatic Slovenica d.d. Koper 2,100 0.23% Total - major shareholders 912,379 97.86% Activities For its own account, SID Bank: • provides pre-shipment and post-shipment financing of international business transactions and international business cooperation, • issues guarantees, • enters into money, currency, capital and derivative market transactions, • provides credit rating and other credit information. On behalf of the Republic of Slovenia, SID Bank as an authorised ECA provides: • short-term export credit insurance against non-commercial and other non-marketable risks, • investment insurance against non-commercial risks, • medium-term export credit insurance against commercial and/or non-commercial risks; • Interest Rate Equalization Programme (IREP), and • other transactions on special authorisations. In line with SID Bank Action Strategy and the newly adopted legislation, the Bank made preliminary preparations for provision of several new activities designed to supplement the existing range of the Bank's services: • international development cooperation (Bilateral Official Development Assistance) in cooperation with the Republic of Slovenia and the Centre for International Cooperation and Development, and execution of certain international development cooperation tasks (financing of bilateral official development assistance). • development financing and insurance in the Slovene market, and • investment financing, in particular securitization. In the light of its policy of sustainable development and long-term financing, these services will ensure diversification of the Bank's service portfolio. _ 8 Annual Report SID Bank - 2006 SID Bank will strive to meet mandates for provision of services in the stated areas and will plan its activities in the year 2007 accordingly. SID Bank operations for the account of the Republic of Slovenia SID Bank performs insurance against non-marketable risks and conducts the Interest Rate Equalization Programme on behalf of and for the account of the Republic of Slovenia. SID Bank is also responsible for the management of contingency reserves which constitute important capacity of SID Bank (and the Republic of Slovenia) for insurance against non-marketable risks before such claims are paid out of the state budget. Contingency reserves are set aside using received premiums, fees and commissions, recourses and other income generated from insurance and reinsurance activities regarding non-marketable risks. Pursuant to ZZFMGP and a long-term contract between SID Bank and the Ministry of Finance, contingency reserves are primarily utilised to settle liabilities to the insureds, pay costs of preventing and reducing future or existing losses, and to cover losses from transactions SID Bank performs on behalf of the State. If the losses cannot be indemnified from the contingency reserves, the funds for claims payments are ensured by the Republic of Slovenia. In these operations as well as in providing financing for international business transactions from funds for which guarantees of the Republic of Slovenia have been issued, a special role is played by the government-appointed International Trade Promotion Commission, besides a number of other competent bodies. The operations which SID Bank as the national export credit agency (ECA) performs on behalf and for the account of the Republic of Slovenia are clearly separated in terms of management and accounting from the operations which SID Bank performs for its own account. Organisation Chart of the SID Bank Group as at 31 December 2006 r ? SID banka, d.d., Ljubljana PRO KOLEKT d.o.o. 80 % 100 % SID - Prva kreditna zavarovalnica d.d., Ljubljana 100 % PRVI FAKTOR -Faktoring d.o.o., Beograd PRVI FAKTOR d.o.o. 100 % 100 % PRVI FAKTOR d.o.o., Sarajevo Annual Report SID Bank - 2006 9 3. SID Bank Group SID Bank constitutes a part of the SID Bank Group a part of which are also: • SID - Prva kreditna zavarovalnica d.d., Ljubljana • PRO KOLEKT, družba za izterjavo, d.o.o., with its subsidiaries • PRVI FAKTOR, faktoring družba, d.o.o. with its subsidiaries At the end of 2006, SID Bank became a co-founder of the Centre for International Cooperation and Development Institute (hereinafter CMSR). SID - Prva kreditna zavarovalnica d.d., Ljubljana Harmonisation of Slovene legislation with acquis communautaire and adoption of new laws, in particular the Act Governing Insurance and Financing of International Business Transactions (ZZFMGP), have spurred changes in the organisation structure of SID and led to the expansion of the SID Group. As the sole owner, SID established a specialised credit insurance company SID - Prva kreditna zavarovalnica d.d., Ljubljana (hereinafter PKZ). In doing that, SID fully harmonised its legal status and operations applicable to insurance business on its own account with the regulation governing insurance company operations. After the newly established company had obtained all the required licenses to carry out insurance operations, it was entered into the Register of Companies on 31 December 2004 with a nominal capital in the amount of SIT 1 billion (EUR 4.2 million). In conformity with the provisions of the agreement and required consents from its supervisory body, SID transferred to its daughter company the portfolio of all insurance operations it had performed on its own account prior to the end of 2004 and which have since 1 January 2005 been conducted exclusively by the newly established insurance company. Through portfolio transfer, insurance policy holders were ensured continuous implementation of the rights and obligations arising from concluded insurance contracts, regardless of the change in its legal status. Transfer of employees from the SID Credit Insurance Department to the new insurance company also guaranteed continuity in terms of human resources and implementation of operations. With regard to ownership and business performance, the operations of PKZ remain an inseparable part of the SID Bank Group, which ensures that despite legal changes the synergy effects of complementary facilities are maintained. The registered principal business activity of PKZ is conclusion and execution of property insurance in the insurance classes of credit insurance and suretyship. The company provides insurance of short-term credits to private-law entities (normally, suppliers' credits of up to 180 days, exceptionally up to 1 year). PKZ also provides insurance against commercial and other marketable risks for companies selling abroad and/or in Slovenia on deferred payment and, normally, on open account. The insurance contracts are normally made on a whole turnover revolving basis covering risks of non-payment in foreign and domestic markets. The company is led by a two-member Management Board, represented by Mr Ladislav Artnik, President of the Board, and Mr Rasto Hartman, Member of the Board. The Supervisory Board has three members. The composition of the Supervisory Board is as follows: Mr Marko Plahuta, President, and Ms Alenka Ferjancic of SID Bank and Mr Ivan Straus, Employee Representative of PKZ. At the end of 2006, the company had 38 employees. The nominal value of the equity interest owned by SID Bank was SIT 1,008 thousand (EUR 4.2 million) as at 31 December 2006. PRO KOLEKT, družba za izterjavo, d.o.o. PRO KOLEKT, družba za izterjavo d.o.o., with its registered office at Ulica Josipine Turnograjske 6, Ljubljana (hereinafter PRO KOLEKT) was established in 2004 by Slovenska izvozna družba, družba za zavarovanje in financiranje izvoza Slovenije, d.d., Ljubljana as its sole owner. The nominal capital of the company was SIT 6.9 million (EUR 28.8 thousand) as at 31 December 2006. Following a decision by the Management Board of SID Bank, the nominal capital was increased by EUR 390 thousand in February 2007. The nominal value of the equity interest owned by SID Bank was SIT 6,892 thousand (EUR 28.8 thousand) as at 31 December 2006. Mr Miloš Varga has been appointed General Manager of PRO KOLEKT. As SID Bank is the sole registered owner of PRO KOLEKT, the General Meeting of PRO KOLEKT is represented by the Management Board of SID Bank. At the end of 2006, the company had three employees. PRO KOLEKT specializes in out-of-court debt collection. Originally, the company was established to perform debt collection for the needs of the SID Group. Today it handles debt collection cases for creditors in Slovenia and Annual Report SID Bank - 2006 10 abroad. Among foreign clients, the principals of PRO KOLEKT increasingly include export credit agencies and debt collection agencies. For foreign creditors PRO KOLEKT performs representation in court proceedings (recovery of debt through court action, forced settlements, bankruptcy proceedings, etc.) and provides credit rating information. Aware of the importance of South-Eastern European markets for Slovene economy and the comparative benefits associated with the presence in the local market, PRO KOLEKT started setting up a network of subsidiaries in 2006 and has established three subsidiaries to date: • PRO KOLEKT d.o.o., Zagreb, Croatia, was founded on 1 February 2006 by PRO KOLEKT, Ljubljana as its sole owner. The nominal capital of the company was SIT 3.2 million (EUR 13.8 thousand). The General Manager of the company is Mr Ivica Balenovic; the General Meeting of PRO KOLEKT d.o.o., Zagreb is represented by the General Manager of PRO KOLEKT, Ljubljana as the sole owner of the company. The nominal value of the equity interest owned by PRO KOLEKT, Ljubljana as at 31 December 2006 equalled the balance of the nominal capital at the same day. • PRO KOLEKT d.o.o., Skopje, Macedonia, was founded on 6 July 2006 and is 80 percent owned by PRO KOLEKT, Ljubljana and 20 percent owned by Štedilnica Mladinec Skopje. The nominal capital of the company is SIT 2.4 million (EUR 10.0 thousand). The General Manager of the company is Mr Goran Markovski; the General Meeting of PRO KOLEKT d.o.o., Skopje is represented by the General Manager of PRO KOLEKT, Ljubljana (as the majority owner of the company) and the Director of Štedilnica Mladinec Skopje. The nominal value of the equity interest owned by PRO KOLEKT, Ljubljana was SIT 1.9 million (EUR 8.0 thousand) as at 31 December 2006. • PRO KOLEKT, društvo za izterjavo dolga, d.o.o., Beograd, Serbia, was founded on 18 December 2006 and is wholly-owned by PRO KOLEKT, Ljubljana. The nominal capital of the company is SIT 6.0 million (EUR 25.0 thousand). The General Manager of the company is Mr Nikola Debač; the General Meeting of PRO KOLEKT, društvo za izterjavo dolga, d.o.o., Beograd is represented by the General Manager of PRO KOLEKT, Ljubljana as the sole owner of the company. The nominal value of the equity interest owned by PRO KOLEKT, Ljubljana as at 31 December 2006 equalled the balance of the nominal capital at the same day. PRVI FAKTOR, faktoring družba, d.o.o. PRVI FAKTOR, faktoring družba d.o.o., with its registered office at Slovenska cesta 17, Ljubljana (hereinafter PRVI FAKTOR) is the leading factoring company in Slovenia. The principal business activity of the company is performance of factoring services for clients with registered offices in the Republic of Slovenia and abroad with regard to claims arising from sales of goods and services. The company provides the following services: repayment assumption or purchasing of claims arising from sales of goods and services with or without protection against the risk of non-payment, financing of purchased claims, claims management, encashment and collection of claims, trading in claims, mediation and representation in factoring transactions in Slovenia and abroad. In 2002 SID acquired a fifty percent equity interest and a half of the voting rights in the company PRVI FAKTOR, the other shareholder being Nova Ljubljanska banka d.d., Ljubljana. The nominal value of the equity interest owned by SID Bank was SIT 140.0 million (EUR 584.2 thousand) as at 31 December 2006. Acting on the decision of the General Meeting of Shareholders of 13 February 2007 SID Bank paid for an increase in capital of EUR 1 million on 21 December 2007. The ownership share of SID Bank remained unchanged after the capital increase. The company is led by the General Meeting of Shareholders and General Manager, Mr Ernest Ribič. PRVI FAKTOR, Ljubljana, has founded and is the sole owner of four enterprises: • PRVI FAKTOR, faktoring društvo, d.o.o., Zagreb, Croatia, specializing in other financial intermediation. The company was founded in 2003; its nominal capital is SIT 443.5 million (EUR 1.8 million). The General Manager of the company is Mr Valentin Vičič; the General Meeting is made up of the representatives of PRVI FAKTOR, Ljubljana. • PRVI FAKTOR, faktoring d.o.o., Beograd, Srbija, specializing in other financial intermediation, was founded in 2005. The nominal capital of the company is SIT 131.8 million (EUR 0.5 million). The General Manager of the company is Mr Dmitar Polovina; the General Meeting is made up of the representatives of PRVI FAKTOR, Ljubljana. • PRVI FAKTOR d.o.o., financijski inženiring, Sarajevo, Bosnia and Herzegovina, specializing in other financial intermediation, was founded in 2006. The nominal capital of the company is SIT 12.2 million (EUR 50.9 thousand). The General Manager of the company is Mr Nedim Rizvanovic; the General Meeting consists of the representatives of PRVI FAKTOR, Ljubljana. • On 22 September 2006 PRVI FAKTOR d.o.o., Skopje was entered in the Register of Companies; its nominal capital is SIT 1.2 million (EUR 5 thousand). The company is not operating yet. The nominal value of the equity interests owned by PRVI FAKTOR, Ljubljana in the companies of the PRVI FAKTOR Group as at 31 December 2006 equalled the balance of the nominal capital of these companies at the same day. _ 11 Annual Report SID Bank - 2006 The PRVI FAKTOR Group ended the year with a total of 76 employees, 30 of whom work in the Ljubljana office, 30 in Zagreb, 12 in Belgrade and 4 in Sarajevo. Centre for International Cooperation and Development On 28 December 2006 SID Bank signed the second Amendment to the Agreement Concerning Restructuring of the Centre for International Cooperation and Development Institute (hereinafter CMSR), thus joining the Republic of Slovenia as a co-founder of CMSR with which it had worked closely prior to the signing. The Centre will continue to pursue its existing activities, namely macroeconomic and political analyses of various countries, country risk assessments and similar macroeconomic and other analyses and publicity, while also focusing on the training for performance of international development cooperation activities and other areas. Annual Report SID Bank - 2006 12 4. International Economic Environment and Slovene Economy World economy in 2006 In 2006 the economic growth in the EU was much higher than the year before. According to first figures published by Eurostat, real GDP growth rose by 0.9% in the last quarter of the year in both the EU and the euro area, pushing the total figure for 2006 to 3.3% or 3.4% when contrasted with the last quarter of 2005. GDP growth in the EU reached 2.9%, a significant rise from 1.7% in 2005. In the euro area economic growth rose from 1.4% to 2.6% in 2006. The recovery was underpinned by export growth and robust domestic demand. High economic growth was shared by the old and new EU member states. Unlike the year before, economic growth in 2006 was also favourable in traditional Slovenia's trading partners, in particular Germany and Austria. According to first estimates, U.S. economic growth came to 3.3% (a slight increase from 3.2% in 2005) and was 2.2% in Japan (1.9% in 2005). Mainly on account of strong domestic demand, GDP growth in the Russian Federation climbed to a high 6.7%. In terms of economic growth, 2006 was favourable for the countries of former Yugoslavia. In Croatia, economic growth was high for the first half the year, but calmed down in the second half, closing the year at 4.7%, staying close to the 2005 level (4.2%). The growth rate in Bosnia and Herzegovina was a high 5.3%. Modest growth in industrial production kept the growth in Macedonia below the forecasts at 3.5%. Serbia's economy rose at a rate of 5.8% in 2006, lagging behind the 2005 figures due to a decline in private and investment consumption. The US and German stock indexes increased at an annual rate of 16% and 22%, respectively, whereas the Japanese stock exchange index recorded a modest 7% growth. The profitability of German state bonds followed the trends in key interest rates set by the European Central Bank. The average yield of German state bonds with a 5-year maturity period was 3.2% in the first half of the year, and ended the year at 3.8%. Slovene economy in 2006 According to first estimates from the Statistical Office of the Republic of Slovenia, GDP growth rate went up 5.2% in real tems (5.0% in the first quarter, 4.7% in the second quarter, 5.6% in the third quarter and 5.5% in the last quarter of 2006) and at an even pace. The main factors which pushed Slovenia's GDP growth over its 2005 rate were exports of goods and services and rapid growth of investment in fixed assets. At the current exchange rate GDP amounted to EUR 29,741 million or EUR 14,811 per capita. Relatively high economic growth in the EU and in traditional Slovenia's trading partners such as Russia and the countries of former Yugoslavia led to a rise in commodity exchange, with imports increasing slightly more than exports, which caused external trade balance to contribute negatively to the gDp growth (-0.3 percentage points). Exports recorded a 10.0% growth in 2006. The growth was highest at the beginning of the year but it stabilized during the year to reach approximately 9% at the annual level. In 2006, exports contributed 6.5 percentage points to the GDP volume growth. Imports rose at an annual rate of 10.4%. Exports of goods saw a rise of 10.8%, mainly as a result of high growth in goods exported to the EU countries, which accounted for nearly 70% of Slovenia's exports of goods. Although exports to the countries of former Yugoslavia remained on the increase, the decline in exports of goods to BiH and Macedonia, which started after Slovenia's accession to the EU, continued whereas an increase was recorded in exports to Croatia, Serbia and Montenegro. Imports of goods grew by 10.5%, with a significant increase recorded in imports from non-EU states. Owing to continued active involvement of Slovenia in international trade and capital flows, the average share of Slovenia's imports is growing in imports as well as in investment and private consumption. In 2006 exports and imports of services rose at a slower pace than trade in goods. Exports of services were up by 6.4%. The increase resulted from growth in exports of other services including operational lease, intermediation and other business, professional and technical services and transport. Despite high growth rates recorded in the exports of other services, the Institute of Macroeconomic Analysis and Development of the Republic of Slovenia states that the changes in the structure of Slovenia's exports remain slow, since the share of this group of services accounts for a quarter of the exports of services, whereas the figure climbs to a half of exports of services in the EU states. The groups of other services and transport were the most dynamic categories also as regards growth in imports of services, which stood at 9.5%. According to preliminary data from the Bank of Slovenia, Slovenia's current account deficit totalled EUR 772.8 million and was up from EUR 547.5 million in 2005. Capital flows strengthened in 2006, and the capital and financial account shows a surplus in the amount of EUR 955.5 million, a rise from EUR 403.7 million in 2005. While the increase in the capital account assets was negligible, the structure of the financial account changed considerably. Financial transactions without international cash reserve showed an outflow of EUR 209.5 million, whereas in 2005 capital inflows amounted to EUR 706.4 million. Net capital exports were largely the result of higher investment in securities abroad, coupled with lower borrowing in long-term loans. _ 13 Annual Report SID Bank - 2006 Favourable economic trends in the international environment affected the economic conditions in Slovenia by pushing investment growth figures above the economic growth rates and by causing a gradual reduction in inventory levels. Strengthened foreign demand had a positive effect on the growth in industrial production and contributed to better employment figures in particular with regard to processing industry. As economic trends and labour market indicators improved, the real growth of wages remained slow, with the gross wage per employee increasing by a nominal 4.8% and a real 2.3% according to the estimates for December 2006. The registered unemployment rate was 8.6% in December 2006, much the same as in previous months, with the total number of people employed totalling 833,016. The annual employment growth rate came to 1.4%. The preparations for entering the EMU and the introduction of the euro as the official currency affected Slovenia's economy and the banking sector also in 2006. The Bank of Slovenia continued implementation of its monetary policy in line with Slovenia's obligations following the ERM 2 entry and carried out the final activities for Slovenia's inclusion into the European Economic and Monetary Union. The Bank of Slovenia stepped up its activities aimed at adjusting monetary policy instruments with the structure of ECB instruments, mainly referring to the abolition of foreign currency bills and conversion of temporary foreign currency purchase with permanent foreign currency purchase. In 2006, like in the entire period since ERM entry, the nominal tolar exchange rate fluctuated at the level of the mean central exchange rate. The EUR/SIT exchange rate was fixed on 11 July 2006. Within the limitations set by the ERM 2 entry and the introduction of the euro, the Bank of Slovenia adjusted its interest rates with regard to the needs of Slovenia's economic activity and gradual nominal convergence and managed to keep the interest rates at levels higher than that of ECB. Interest rates went up in August when the Bank of Slovenia increased the interest rates for 60-day tolar bills from 3.25% to 3.50% and the interest rates for lombard loans from 4.50% to 4.75%. Active tolar interest rates for long-term loans to companies went down in November and December 2006. On the other hand, the price of short-term loans to companies rose slightly. Passive tolar interest rates fluctuated throughout the year. The interest rates for deposits with maturity of one year and beyond fell from 2.7% to 1.5% as a result of changeover to the euro. 6M Euribor as the reference inter-bank interest rate of the euro area started the year 2006 at 2.6% and was 3.8% at the end of the year, the rise indicative of macroeconomic indicators and changes in ECB interest rates. In 2006 the credit activity of banks continued to strengthen and promote financial deepening and conversion of economy from foreign to domestic sources of funding also due to narrowed differences between interest rates in Slovenia and abroad. Additionally, the free flow of capital and the process of accession to the euro area have provided banks with easy and low-cost access to sources of financing abroad. The volume of loans extended to the non-banking sector rose at a monthly rate of 1.8%, with the growth rate of foreign currency loans to companies and non-financial institutions rising to over 40%. The first two quarters of 2006 saw a continuation of the decline in tolar portfolio resulting from a reduction in indebtedness of both the banking sector and companies and non-financial institutions and other non-banking entities, which calmed down in the second half of the year due to a rise in private indebtedness in tolars. In the capital market the Slovene stock exchange index SBI20 reached a record, having gained 38% in the year 2006 and reaching a record 6465 points on 8 December 2006. The Slovene stock exchange index of bonds (BIO) dropped 2.98% in 2006. As a result of coordinated economic policies of the Bank of Slovenia and the Government of the Republic of Slovenia, growth of prices remained under control also directly prior to the adoption of the euro. Inflation rose from 2.3% in 2005 to 2.8% in 2006. The average year-on-year inflation measured with the harmonised consumer price index amounted to 2.5%. Influence on SID operations • in financing of international business transactions The above business trends of the banking and corporate sectors and their impact on economic trends had a marked influence on SID operations concerning financing of international business transactions. In the first half of 2006 there was a strong reduction of bank indebtedness with regard to tolar refinanced loans, coupled with an increase in foreign currency loans, mostly euro loans, causing SID to achieve a turnover of SIT 79.8 billion (accounting for over 40% of the total credit portfolio at the end of 2006). Pricing pressure from commercial banks and companies led to a considerable drop in interest rates linked to sources of financing and can be held responsible for a modest interest-generated income. The pressure for lower interest rates did not only affect Slovenia but is increasingly affecting foreign markets, in particular in the states applying for EU membership and in new EU member states (Bulgaria, Romania, Croatia, Serbia, Montenegro) and in the Russian Federation (impact of higher oil prices, decrease in state indebtedness, investment growth). Annual Report SID Bank - 2006 14 Increased trade in goods caused a rise in the volume of financing extended to EU residents both in direct terms, through commercial banks, and indirectly. The presence of Slovene companies in the markets of Central and Eastern Europe increased in 2006, as is evident from the growing demand of Slovene investors and exporters for direct funding of projects in foreign countries, provided mainly through direct funding of a Slovene investor or through funding extended to a foreign buyer of Slovene services and goods. SID Bank supports such projects and international business transactions in cooperation with commercial banks (syndicated loans, club deals) or independently and strengthens its partnerships with Slovene and international commercial banks. At the end of 2006, foreign currency deals took up almost a quarter of the overall credit portfolio of SID Bank. • in treasury transactions Considering that the domestic (tolar) and foreign (euro) interest rates were equalized in 2006 although convergence did not occur until the end of the year, Treasury transactions were mainly in tolar-denominated fixed-rate instruments. Tolar interest rates were higher than the interest rates for transactions in euros. Consequently, the euro position was cut back. The changes in currency markets had no marked effect on SID Bank as most of its balance sheet was denominated in EUR or SIT. As a result of the Bank's balance sheet composition, no significant exposure occurred. Variable-rate investments and variable-rate liabilities linked to 6-month Euribor take up a significant portion of assets and liabilities, respectively. Owing to its year-round excess liquidity position, Treasury did not take out borrowing without state guarantees as it focused mainly on placement of excess liquidity. Furthermore, Treasury activities in 2006 were negatively affected by the obligation to pay interest rate tax for loans taken out in foreign countries without the state guarantee. • in insurance on behalf of and for the account of the state Favourable macroeconomic conditions in Russia, political stability, export growth caused by the strong and stable domestic currency, good payment discipline of Russian buyers, having shown a strong improvement over the last three years, and strong domestic demand as the driving force behind economic growth were the key factors that generated outstanding demand for insurance of exports in Russia which, in terms of the volume of business insured, remains the most important SID Bank market for medium-term export credit insurance. Transactions insured chiefly cover construction projects and exports of high technology and other equipment. With regard to the other countries formed in the area of the former Soviet Union, SID, in conducting insurance on behalf of and for the account of the state, supported Slovene exporters in Kazakhstan that was not faced with any significant changes of country risk in 2006, and is also processing several other projects involving other CIS markets. In 2006 SID Bank entered into an export credit insurance transaction with Algeria. Although Algeria is currently not an important partner of SID Bank in insurance on behalf of and for the account of the state, SID as the national credit agency, acting in compliance with its current insurance policy, is interested in supporting export transactions to the country. Due to the recent developments regarding the application of nuclear technology in Iran and the international attitude to the issue, the Intervention Group of SID Bank held a few sessions on Iran and has so far agreed to decide on a case-by-case basis and under certain insurance conditions whether to extend the coverage of export transactions and issue of insurance coverage to the country. In accordance with the prudent assessment of country risk, SID Bank performed insurance of risks to Iran in accordance with its risk appetite for the large part of the year 2006, mostly due to favourable macroeconomic conditions in the country, which were evident in the relative high credit rating, and on account of previous positive experience with debt settlement. In compliance with the UN Security Council Resolution which called upon UN member states to prevent all transfers of raw materials, equipment or technology that could contribute to Iran's nuclear and missile programs and to freeze the assets of companies and individuals involved in Iran's nuclear and missile programs, in December 2006 SID Bank, like most ECAs, took a reserved yet positive standpoint towards future support to exports to Iran, thus slowing down the process of conducting insurance of exports to the country. In 2007, SID Bank will continue to observe the developments and measures taken with regard to Iran, and the Bank's strategy of insurance will depend on further developments in the nuclear program dispute and the political situation in the country. Despite the predictions made at the beginning of 2006 about the possible adoption of measures against Iran and the subsequent implementation of sanctions against the country, Iran remains, from the point of view of Berne Union members, one of the three largest world markets in terms of export credit insurance volume. In 2006 SID regularly followed the changes in the classification of countries and territories prepared by OECD for the needs of setting minimum premium rates. Throughout the year, SID adapted its internal classification of countries by risk category accordingly. Owing to improved country risk status all the countries which were reclassified in 2006 were moved to a lower risk category, except Iran that was classified as belonging to Category 5 in the first half of the year: Macedonia, Armenia, Libya and Cape Verde went from Category 7 to Category 6, Azerbaijan, Dominican Republic, Guatemala, Uruguay and Papua New Guinea went from Category 6 to Category _ 15 Annual Report SID Bank - 2006 5, Brazil and Columbia went from Category 5 to Category 4, Namibia and Morocco went from Category 4 to Category 3, Cyprus and Bahrain went from Category 3 to Category 2, whereas Czech Republic and Slovak Republic went from Category 2 to Category 1. Influence on operations of other companies within the SID Bank • SID - Prva kreditna zavarovalnica (PKZ) Owing to the characteristics of credit insurance, national economic conditions in Slovenia and in the markets where PKZ clients perform their business activities have a considerable influence on the operations of PKZ. Among the most important economic indicators are economic growth, inflation rate, export and import of products and services. These indicators can significantly affect the volume of transactions to be insured and potentially also the business operations of PKZ. The reason for this is that economic conditions are normally the major contributor to the PKZ loss ratio. PKZ underwrites risks in a number of countries. However, PKZ operations are most sensitive to the economic situation in the countries that form the largest part of the total PKZ portfolio in terms of premiums, business volume or exposure. According to the above-mentioned criteria, PKZ main markets include Slovenia, Germany, Croatia, Italy, Serbia, Russia, Bosnia & Herzegovina, and France. • PRVI FAKTOR Group The conditions in the Slovenia's financial market had an important effect on the business operations of PRVI FAKTOR, Ljubljana, in particular through the constant pressure to reduce interest rates. Successful performance of the PRVI FAKTOR Group depends heavily on the situation in Croatia and Serbia, where the overall conditions are favourable for factoring services as these markets deal in high-quality receivables insurance instruments in the form of drafts, and also debentures in Croatia. The market for drafts, which are both payment and insurance instruments in a large part of business transactions conducted in Croatia and Serbia, is much larger in these markets than it is in Slovenia. • PRO KOLEKT Group Collection of debts is under strong and direct influence of conditions governing national economies, evident mainly in the liquidity situation and likelihood of default. In addition to operating in Slovenia and its neighbouring countries, PRO KOLEKT has established a network of debt collection agencies in 70 states. Nevertheless, the largest part of its operations is limited to the markets of the main importers of Slovene goods and services and the majority of business partners of Slovene companies. So far, the number of collection cases performed by PRO KOLEKT has been highest with regard to Slovenia and Croatia, Serbia, Bosnia and Herzegovina, and Germany, which makes these countries the most important markets for the operation of the PRO KOLEKT Group. Annual Report SID Bank - 2006 16 5. Development Strategy of SID Bank The future role and position of SID Bank are defined in the Action Strategy of SID Bank for the period 2006-2010, which was adopted at the Supervisory Board Meeting on 3 November 2006. Mission The mission of SID Bank is to develop, provide and promote innovative, public and long-term financial services designed to supplement financial markets, for sustainable development of Slovenia. Vision It is with dedication to its mission, acquisition of new knowledge and skills and development of optimal solutions tailored to the needs of Slovene companies and banks that by the year 2010 SID Bank will become a main promotional institution whose comprehensive range of services complementary to the financial market will continue to be an important factor of Slovenia's economic growth. On this basis, the Bank will increase its total assets by at least 100%, while at the same time maintaining its financial stability and bringing its share of new activities (in the total volume of business) to a minimum of 15%. By assisting clients in all phases of business transactions, supporting development projects, ensuring safety in internationalization of operations and providing all modern financial services in one place, SID Bank will facilitate Slovene companies to exploit the opportunities opening up in the international economic and development cooperation. The Bank will strive to achieve these objectives mainly through the provision of long-term financing and insurance facilities. Transparent, efficient and socially responsible SID Bank operations sensitive to the needs of its employees and customers, in particular SMEs, and implementation of the objectives of Slovenia's development strategy will be the framework on which SID Bank will base its efforts - to be seen as an effective and valued development partner. Strategy SID Bank will continue its activities in the field of financing international economic cooperation and further development of export insurance and financing system in the Republic of Slovenia and will gradually transform from a company specializing in promotion of pre- and post-shipment insurance and financing into a specialized bank which will, in addition to its existing range of activities, also perform a comprehensive range of development and promotional activities complementary to financial markets. In export insurance against non-marketable risks SID Bank will continue to perform its role of an authorised national export credit agency (ECA), striving to ensure competitive and safe business for Slovene companies in international markets. In accordance with its new orientations and legal framework the Bank will continue to promote international economic cooperation and internationalization of Slovenia's economy, striving to achieve: • further improvement of financing and insurance conditions for Slovene economy and cooperation with commercial banks, bank consortia and other financial institutions in facilitating of a variety of forms and methods of financing and insurance of their operations and international business cooperation, • active development of long-term financing for Slovene exporters (in particular medium-term and long-term pre- and post-shipment financing of foreign buyers/banks and their investments abroad), • financing and insuring of the transactions and development of small- and medium-sized enterprises (SMEs) as a contribution to faster inclusion of SMEs into the international economic environment and thus a faster development of this economic segment in the Republic of Slovenia, • support to the development of economic entities for faster inclusion into international economic circles and achieving a high rate of internationalization with financial support for research, development, environment protection, sustainable development, employment and education and training in Slovene and foreign markets, • introduction of new financing instruments to facilitate more effective development and export activities of the economic sector and, in particular, international development cooperation and development of other options that would enable providing of new services supplementary to financial markets, which involve instruments of mortgage and municipal financing and securitization. Through development of innovative solutions tailor-made to the needs of Slovene companies and banks, SID Bank will establish itself as one of Slovenia's main public promotional institutions and will, thanks to its comprehensive range of services complementary to the financial market, continue to be seen as an important growth factor in Slovenia's economy and sustainable development. Annual Report SID Bank - 2006 17 6. Review of SID Bank Operations in 2006 6.1. Financial review of SID Bank operations In 2006 SID achieved its planned business objectives and generated positive results in both principal business segments: financing and issue of guarantees for international business transactions. The presentation of financial review and financial position of SID over the years 2006 and 2005 is based on financial statements, prepared in accordance with the International Financial Reporting Standards (IFRS). Income statement summary 2006 2005 2006 2005 in SIT thousand in EUR thousand Net interest 1,797,150 1,798,235 7,501 7,504 Net non-interest income 595,596 750,403 2,486 3,131 Labour, general and administrative costs -1,142,355 -946,785 -4,768 -3,951 Depreciation -103,612 -97,567 -432 -407 Impairments and provisions -325,684 1,023,374 -1,359 4,271 Pre-tax profit 829,687 2,527,498 3,463 10,547 Corporate income tax -216,887 -624,483 -905 -2,606 Net profit 612,800 1,903,015 2,558 7,941 In 2006 net profit amounted to SIT 829.7 million (EUR 3.5 million). Net interest income totalled SIT 1.8 billion (EUR 7.5 million) and remained at the level achieved in 2005. As a result of strong growth of credit volumes and an increase in Euribor, interest income rose 46.0% over the year 2005, totalling SIT 6.6 billion (EUR 27.3 million). On the other hand, interest expenses climbed 76.8%, pushing the figure up to SIT 4.8 billion (EUR 19.8 million). Net non-interest income amounted to SIT 595.6 million (EUR 2.5 million), the drop of 20.6% from the 2005 level caused mainly by lower realized net fees and commissions and the impact of foreign exchange losses. Income from net fees and commissions related to financing, guarantees and treasury transactions reached SIT 60.4 million (EUR 0.25 million) of the total net non-interest income. Income from reimbursement SID receives from the state subject to the Agreement on the regulation of mutual relationships concerning implementation of Chapter II of the Act Governing Insurance and Financing of International Business Transactions amounted to SIT 497.3 million (EUR 2.1 million). In 2006 operating costs totalled SIT 1.2 billion (EUR 5.2 million) and were 19.1% up from the year 2005, mostly due to higher costs of labour related to an increase in employee numbers and the costs of services linked to SID's transition into a bank. In the structure of operating expenses, labour costs accounted for 57.9%, cost of services 31.1%, depreciation 8.3% and cost of materials 2.7%. The percentage of operating costs as of assets lowered from 0.78% in 2005 to 0.71% in 2006. Net expenses from impairments and provisions totalled SIT 325.7 million (EUR 1.4 million), whereas in 2005 SID recorded income from impairments and provisions in the amount of SIT 1.0 billion (EUR 4.3 million). Balance sheet summary 31.12.2006 31.12.2005 31.12.2006 31.12.2005 in SIT thousand in EUR thousand Bank loans 166,394,630 123,804,076 694,352 516,764 Deposits from non-bank sectors 10,185 392,739 43 1,639 Provisions 417,524 714,672 1,742 2,983 Other liabilities 1,423,857 1,151,790 5,942 4,808 Equity 25,017,939 24,744,098 104,398 103,283 Total liabilities 193,264,135 150,807,375 806,477 629,477 Contingency reserve 24,611,935 22,311,917 102,704 93,131 IREP 350,003 0 1,461 0 Impairments of financial assets measured at amortised cost and provisions 3,362,757 3,082,954 14,033 12,868 Volume of off-balance-sheet business 61,365,556 71,315,274 256,074 297,673 Annual Report SID Bank - 2006 18 As at 31 December 2006, total assets of SID Bank stood at SIT 193.3 billion (EUR 806.5 million), showing a year-on-year increase of 28.1%. Contingency reserve for insurance carried out for the account of the state and the corresponding contingent liabilities rose by 10.3% in 2006 to SIT 24.6 billion (EUR 102.7 million). With the volume of borrowing concluded with the guarantee of the Republic of Slovenia increasing, bank loans rose 34.1% to account for SIT 166.4 billion (EUR 694.4 million), or 86.1% of total liabilities. At the end of 2006, the Bank's equity stood at SIT 25.0 billion (EUR 104.4 million), and had increased by 1.1% through generated net profit. 31.12.2006 31.12.2005 31.12.2006 31.12.2005 in SIT thousand in EUR thousand Financial assets available for sale 8,485,919 6,432,778 35,411 26,851 Loans to banks 142,387,944 107,852,921 594,174 450,183 Loans to non-bank customers 39,383,193 34,078,504 164,343 142,245 Tangible fixed assets and intangible long-term assets 1,380,489 768,550 5,761 3,208 Long-term investments in equity of SID Bank Group companies 1,515,112 1,510,320 6,322 6,304 Other receivables 111,478 164,302 465 686 Total assets 193,264,135 150,807,375 806,477 629,477 Investments of contingency reserves 24,611,935 22,311,917 102,704 93,131 Investments from IREP 350,003 0 1,461 0 In 2006 growth of total assets again resulted from intensive financing of international business transactions. Loans to banks increased by 32.0% to SIT 142.4 billion (EUR 594.2 million). There was a 15.6% increase in loans to non-bank customers, making up SIT 39.4 billion (EUR 164.3 million). At the end of 2006 SID Bank held debt securities in the amount SIT 8.5 billion (EUR 35.4 million), marking a year-on-year increase of 31.8%. The purchase of a part of an office building which houses the headquarters of SID Bank has led to an increase in tangible fixed assets. Key figures 2006 2005 Shares - number of shareholders 87 87 - number of shares 932,354 932,354 - nominal value per share (in SIT thousand) 10 10 - book value of a share (in SIT thousand) 27.37 26.54 Selected indicators Capital: - capital adequacy* 20.7% 26.3% Quality assets of on-balance sheet and contingent liabilities: impairments of financial assets measured at amortised cost, and provisions for contingent liabilities/classified on-balance sheet assets and classified off-balance- 1.85% 1.95% sheet items* Profitability: interest margin 1.03% 1.35% financial intermediation margin 1.37% 1.91% return on assets before taxation 0.47% 1.90% return on equity before taxation 3.32% 10.61% return on equity after taxation 2.45% 7.99% Operating costs: operating costs / average assets 0.71% 0.78% Liquidity: liquid assets / short-term deposits from the non-bank sector 0.03% 0.01% liquid assets / average assets 0.00% 0.00% Number of employees 68 62 * The calculations consider investments from own assets of SID Bank and investments from funds secured with the guarantee of the Republic of Slovenia. Annual Report SID Bank - 2006 19 6.2. Pre-shipment and Post-shipment Financing of International Business Transactions In 2006 one of SID's main activities was financing of (preparation for) international business transactions, mainly by providing indirect exporter financing, through banks and other financial institutions, in particular by refinancing loans for pre- and post-shipment financing of international business transactions. The financing facilities provided by SID included loans (short-term and long-term), purchase of receivables, project financing, participation in syndicated loans, acquisition of assets, risk takeover, etc. Through this activity SID has significantly contributed to the increase in the capacity of commercial banks and exporters for financing international business transactions. In financing export transactions, as in export credit insurance, SID covers all phases of international trade: • pre-shipment financing and • post-shipment financing. SID Bank provides pre-shipment and post-shipment financing of international business transactions from: • own funds of SID Bank • funds obtained with the guarantee of the Republic of Slovenia, • contingency reserves. The credit portfolio structure follows the structure of funds where investments from funds obtained with the guarantee of the Republic of Slovenia held the largest share of the credit portfolio, the share of investments from own funds was 8.4% and the share of investments from contingency reserves was 7.0%. In the continuation of the report the structure of SID credit portfolio in 2006 is presented. The 2005 and 2006 data are based on financial statements prepared in accordance with IFRS. Volume of financing • SID financing 2002-2006 2002 2003 2004 2005 2006 outstanding as at 31 December (in SIT billion) 73.6 97.6 119.8 146.4 181.4 outstanding as at 31 December (in EUR million) 319.6 412.4 499.7 611.0 757.0 In 2006 SID Bank actively cooperated with most Slovene banks in financing of (preparation for) international business transactions. The year 2006 was marked by preparations of the economic and banking sectors for entry to the EMU and favourable trends concerning internationalization of Slovene economy, which led to an increase in demand for SID funds in foreign currency, mostly euros, both from the banking and corporate sectors. Compared to 2005 when the outstanding amount of SID financing was SIT 146.4 billion (EUR 611.0 million), financing operations in 2006 rose by 23.9% and totalled SIT 181.4 billion (EUR 757.0 million) at the end of the year. The share of financing portfolio in total SID Bank assets was 83.1 %. SID financing by year (in SIT billion) 200 - 150 -100 -50 -0 - 2002 2003 2004 2005 2006 ■ nil The growth rate of SID financing (23.9%) was at the level of the annual growth of all loans extended to the Slovene corporate sector, with the share of SID Bank financing in all loans extended to the Slovene corporate sector in 2006 (direct and indirect) reaching 5.4%. According to first estimates from the Statistical Office of the Republic of Slovenia, Slovene exports saw a 10.0% growth in the year 2006, which means that the growth rate of SID financing in 2006 was substantially higher than the growth rate of Slovene exports. Annual Report SID Bank - 2006 20 Portfolio structure • By maturity In 2006 the maturity structure of SID Bank credit portfolio confirmed the orientation of SID Bank towards long-term financing of international business transactions with the share of long-term financing amounting to 88.6% of SID Bank credit portfolio at the end of the year. SID Financing: Outstanding amounts by maturity 2002 - 2006 2002 2003 2004 2005 2006 - Financing by maturity (in SIT billion) long-term 34.2 55.2 75.9 126.3 160.7 short-term 39.4 42.4 43.9 20.1 20.7 total 73.6 97.6 119.8 146.4 181.4 - Financing by maturity (in EUR million) long-term 148.5 233.2 316.6 527.2 670.6 short-term 171.1 179.1 183.1 83.9 86.4 total 319.6 412.4 499.7 611.1 757.0 The growth of 27.3% in long-term credit portfolio was largely due to a steep rise in foreign currency lending, making up nearly 40% of the long-term segment. 200 -150 -100 -50 - 0 - 2002 2003 2004 2005 2006 □ Long-term □ Short-term • By currency As Slovenia adopted the euro as its official currency in 2007, the interest of exporters and their commercial banks for foreign currency financing strengthened significantly in 2006. As a result, SID foreign currency credit portfolio climbed 32.8% year-on-year to SIT 161.9 billion (EUR 675.6 million), accounting for 89.3% of the total SID credit portfolio at the end of 2006. The decline in tolar credits continued throughout 2006, ending the year at SIT 19.5 billion (EUR 81.5 million). Compared with 2005, tolar financing decreased in the long-term (down by 35.4%) segment whereas short-term tolar financing went up by 5.5%. Foreign currency financing, conversely, saw a substantial rise with the long-term segment up 35.9% and the short-term segment remaining at the level of 2005. SID Financing: currency structure as at 31 December 2006 (in SIT billion) 180 160 140 120 100 80 60 40 20 0 I 2002 2003 2004 □ Loans in domestic currency By borrower 2005 2006 □ Loans in foreign currencies 21 Annual Report SID Bank - 2006 In 2006 commercial banks remained the most important SID partner in financing international business transactions and preparation for international business transactions (including outward investment), their share in SID Bank portfolio reaching 78.7% at the end of the year. The demand for direct financing of projects of Slovene exporters abroad and for pre-shipment financing increased steadily throughout 2006, showing a 13.5% increase on the year before for loans extended to customers other than banks. Despite a significant growth in loans to customers other than banks, this segment represented only 21.3% of the total loan portfolio in 2006. The share of loans to non-residents in the SID Bank credit portfolio remains a low 7.4%, as most placements for support to realization of international business transactions were performed indirectly, through commercial banks. SID Financing: By borrower as at 31 December 2006 (in SIT billion) 160 140 120 100 80 60 40 20 0 2002 2003 2004 2005 2006 □ Loans to banks □ Loans to non-bank customers • By risk Despite a considerable increase in the volume of direct financing of Slovene exporters, their buyers and investors abroad, high quality of SID financing portfolio abroad remained unaffected in 2006 since the investments classified in classes lower than A and B only take up 0.4% of the SID credit portfolio. For more information on portfolio risk and portfolio classification in accordance with IFRS see Point 6.8. Income from SID financing In 2006 SID Bank generated SIT 5,744.8 million (EUR 23.0 million) in interest income from financing. The pressure to lower investment interest rates has neutralized the impact of gradual increase in Euribor throughout the year, causing net interest income to reach 2005 levels at the end of the year 2006. Received fees and commissions from these operations totalled SIT 167.2 million (EUR 697 thousand). Annual Report SID Bank - 2006 22 Guarantees Guarantees are a welcome supplement to the range of services SID Bank provides for Slovene companies in the field of insurance and financing as it enables them to obtain deals through guarantees which domestic and foreign beneficiaries consider a first-class protection instrument against counter-party risks related to contractual obligations and other contractual relations. Guarantees issued at request may also be insured with SID Bank against non-commercial risks and risk of unfair calling, which is important for banks (guarantors) and companies (obligors) alike. Volume of guarantees Guarantees: business volume 2002 - 2006 2002 2003 2004 2005 2006 volume of issued guarantees (in SIT billion) 6.1 9.5 7.9 11.1 10.6 volume of issued guarantees (in EUR million) 27.0 40.7 33.2 46.2 44.2 outstanding (value as at 31 Dec.) (in SIT billion) 8.0 8.4 8.2 11.2 8.6 outstanding (value as at 31 Dec.) (in EUR million) 34.6 35.3 34.2 46.9 36.0 honoured (in SIT billion) 0.5 0.6 0.2 - - honoured (in EUR million) 2.1 2.7 0.7 - - recourse (in SIT billion) 0.1 0.1 0.2 0.1 0.1 recourse (in EUR million) 0.0 0.0 0.8 0.4 0.4 Guarantee volume met the goals set for the year 2006. The value of guarantees issued in 2006 was only 5% down from the year 2005 when the volume of issued and outstanding SID guarantees was particularly high thanks to the successful execution of a large short-term transaction. The quality of SID guarantee portfolio improved significantly in 2006 as guarantee investments rated A or B take up over 99% of the total guarantee portfolio. For more information on portfolio risk and portfolio classification in accordance with IFRS see Point 6.8. SID Bank guarantees: issued and outstanding, 2002 - 2006 (in SIT billion) 12 n 10 8---- ------ 6--- - - --- 4----------- 2-- - - --- 0 J----1----1----1----1--- 2002 2003 2004 2005 2006 □ Volume □ Outstanding Annual Report SID Bank - 2006 23 6.3. Borrowing In compliance with the Act Governing Financing and Insurance of International Business Transactions (ZZFMGP), SID Bank as an authorised export credit agency strives to obtain favourable sources of long-term financing in international markets and utilises these sources to support internationalization of Slovene economy, that is pre-and post-shipment financing of international business transactions. In selecting borrowing instruments, SID Bank focuses on flexible instruments that can be tailored to investment needs. SID Bank has a diversified portfolio of borrowings, funds obtained varying in maturity, size and dynamics of disbursements. Pursuant to ZZFMGP the Bank aims to obtain long-term funding with a maturity of up to 20 years, which is comparable with the funding provided by the Republic of Slovenia. Having obtained its banking licence in 2006, SID Bank will be even more active and flexible in obtaining funds in international financial markets in the future. Favourable long-term financing of SMEs In 2006 SID offered and successfully completed a special program aimed at providing favourable long-term financing to SMEs (and sole proprietors), which was carried out through selected Slovene commercial banks in cooperation with the German Kreditanstalt für Wiederaufbau (KfW) and the Council of Europe Bank (CEB). Long-term sources of funding for financing international business transactions and internationalization In order to provide Slovene companies and their commercial banks with favourable long-term funding for financing of (preparation for) international business transactions in foreign currencies, SID continued raising funds in international financial markets, which started in 1999. SID Bank and HSH Nord Bank signed a long-term framework agreement for a successive issuance of Schuldscheins (debt certificates) in the amount of EUR 292 million and the duration of indebtedness up to 15 years. Schuldschein is an instrument of indebtedness typical of the German market. Schuldscheins have the elements of a loan but resemble securities in the way they are traded in the capital market. Investors in Schuldscheins include insurance companies, commercial banks and mortgage banks. In accordance with the existing contracts, SID Bank issued debt certificates with a maturity of five, seven and ten years in the year 2006. Through its continuous presence in international financial markets, SID Bank is building on its position of a first-class partner with an excellent track record. In the future, this reputation will continue to enable the Bank to access the funds for financing international business activities of Slovene companies under favourable conditions. Annual Report SID Bank - 2006 24 6.4. Treasury SID Bank Treasury manages the liquidity of the Bank's accounts and closes deals with instruments of the monetary, capital and foreign currency markets and derivative instruments. In closing deals in the financial market Treasury operates as a separate business unit, but on the other hand, the role of Treasury is of particular importance with regard to the company's balance sheet management and management of liquidity, interest rate and currency risks. Loans & Guarantees are separated from treasury operations in such a way that the Loans & Guarantees grants loans regardless of the SID Bank balance sheet segment and raises funds with state guarantees, whereas Treasury secures funds without state guarantees and manages assets, except loans, regardless of the SID Bank balance sheet segment. Besides, Treasury mitigates market risk for all SID Bank balance sheet segments. Treasury manages, in part or in total, four portfolios: • investments from own funds of SID Bank • investments from funds obtained with the state guarantee • contingency reserve and • IREP reserve. The procedure of entering into the stated transactions is governed by the Bank's internal acts, which specify the decision-making process, authorisations and potential risks SID Bank may encounter in treasury transactions. SID Bank investments are held in the banking book, with securities investments classified as assets available for sale. Transactions in derivatives are held in the trading book, given that the volume of these transactions does not exceed EUR 15 million or 5 percent of all transactions conducted by SID Bank. The investments held by SID Bank Treasury are aimed at controlling liquidity, currency and interest rate risks. Own funds of SID Bank The volume of Treasury investments from SID own funds accounted for 35.4% of total own assets at the end of 2006. Treasury conducted transactions with partners (issuers/debtors) rated BBB- or higher, with Slovene banks and unrated subsidiaries whose credit rating under the methodology of SID Bank was not lower than B. The currency structure of investments corresponded with the currency structure of SID assets and was constantly coordinated with adopted limits. Treasury also coordinated the maturity structure of assets and liabilities. As for the type of interest rate, the major part of investments (80%) was taken up by fixed rate investments, and the composition was adjusted to the trends in the interest rate market. As a rule, SID Bank does not hold investments that are not settled by an independent institution. Priority is given to investments which can be used in concluding REPO transactions and investments which can be, on the basis of currently valid decisions of the Bank of Slovenia, considered in calculation of all types of liquidity ratios or can be used as the basis for calculating the liquidity of the European Central Bank. On account of lower transaction costs, primary market investments are preferred over secondary market investments. SID Bank operates in the financial markets of EEA and OECD member states In 2006 the volume of borrowing in money market instruments taken out without state guarantees was quite low, the majority of funds obtained from banks dealing in derivatives with maturity of up to one year. Passive transactions were denominated in EUR or SIT with a maturity of up to one year and a fixed interest rate. As for borrowing, SID Bank's operations in the Slovene financial market were highly limited due to the Bank's excess liquidity position, since it would be obliged to pay interest rate tax if it entered into borrowings in foreign markets without the state guarantee. SID is not an authorised participant in the securities market. Transactions in securities were concluded as an investment option supplementing the Bank's ordinary activities and to manage the liquidity risk and not for the purpose of trading. All investments are held in the banking book and classified as assets available for sale. Treasury investment from own funds of SID Bank as at 31 December 2006 amounted to SIT 10.2 billion (EUR 42.6 million). Investments include Slovene and foreign government bonds, market bonds issued by other issuers, and deposits. The majority of investments are denominated in EUR or SIT. With regard to investment policy, the highest priority is given to investment-grade investments. About two thirds of all investments are rated A (S&P), and a fifth is held in investments to unrated issuers (Slovene banks). Fixed-rate investments to residents are the predominating form of investment. SID Bank funds from sources of funding obtained with state guarantee A detailed definition of SID Bank's investment structure is given in the Rules on the Implementation of Loans for Financing International Trade and Investments. In this segment of SID operations, Treasury only held investments _ 25 Annual Report SID Bank - 2006 in deposits of commercial banks for the purpose of liquidity control and other investments in short-term debt instruments issued by high-rated issuers. In liquidity control, Treasury followed the strategy of reduced risk concentration, which means that the liquidity surplus was invested in banks to which SID has a low exposure. Derivative financial instruments were not used in this segment of SID operations, since activities were dominated by the policy of closed foreign currency position and the policy of interest rate harmonisation (variable, linked to 6-month Euribor) and maturity of both assets and liabilities. Treasury investments from SID own funds aimed at liquidity control totalled 6.7% of SID investment from sources of funding obtained with state guarantee at the end of 2006. Treasury investments from sources of funding obtained with state guarantee as at 31 December 2006 amounted to SIT 11.0 billion (EUR 46.0 million) and included deposits to Slovene banks, with a fixed interest rate and denominated in EUR or SIT Contingency reserve Treasury investments from SID contingency reserve totalled 38.1% of the fund at the end of 2006. The variable share of treasury investment - liquid investments - depends mainly on the estimated claims payments and the resulting liquidity position of the contingency reserve. Investment policy pursues the aim of contingency reserve management, that is the capacity to settle insurance claims. Contingency reserve investment policy summarizes the investment policy for cover assets as defined in the Insurance Act, applying, however, an additional restriction that unweighted exposure to a debtor shall not exceed 25% of the contingency fund. The provision does not apply to securities issued or guaranteed by the Republic of Slovenia, Bank of Slovenia, other EU member states and OECD member states, except for Mexico, Turkey and South Korea. Contingency reserve funds are invested in liquid obligations to the amount representing the sum of all potential claims and claims under consideration from non-marketable risks insurance or not less than 20% of investments from contingency reserve funds. Debt securities quoted on the organized market and all other debt documents with residual maturity under one year are considered liquid investments. Provisions of the Insurance Act apply mutatis mutandis in controlling the currency structure of investments from the contingency fund. Investments from contingency reserves which expose the Bank to risks of potential losses resulting from foreign exchange rate changes have to be coordinated with the Bank's liabilities arising from insurance policies and contracts the amount of which depends on foreign exchange rate changes, to the extent not lower than 80%. Net exposure by currency is the basis for determining the currency structure. Net exposure is the sum of all exposures from assumed non-marketable risks. Treasury investment from contingency reserve as at 31 December 2006 amounted to SIT 11.0 billion (EUR 38.1 million). These investments consist largely of short-term and long-term securities and bank deposits. The major part of all investments is taken up by A-rated (S&P) investments, with the share of investments to residents rising to 71.2%. Other treasury services SID Bank's Treasury operates as the SID Bank Group treasury and as such performs technical activities concerning the management of portfolio of cover assets and own assets for a Bank's subsidiary, SID - Prva kreditna zavarovalnica d.d. Ljubljana (PKZ). To a large extent, the structure of investments is specified in the Insurance Act. In 2006 SID Bank Treasury performed control of liquidity and currency risks for PKZ. SID Bank Treasury carries out these services on the basis of the Agreement on Excluded Treasury Transactions and in accordance with the decisions taken by the Management Board of PKZ, by placing orders with authorised market participants on behalf of PKZ. Annual Report SID Bank - 2006 26 6.5. Operations on Special Authorisation - Insurance against Non-marketable Risks Certain commercial and non-commercial or political risks (non-marketable risks) of the nature and level for which private reinsurance market lacks either willingness or capacity to cover are insured by SID Bank as an authorised institution on behalf of and for the account of the Republic of Slovenia. According to the EU legislation, non-marketable risks are defined as commercial and political risks of a time horizon exceeding two years in the OECD countries and all risks in countries which are not OECD members. The role of the state is of key importance as without an insurance cover most such business transactions, especially medium-term, would not be carried out. Furthermore, it is in insurance of such transactions that export promotion as one of the core activities of SID Bank is clearly expressed. Due to the size of transactions and higher risks involved, states remain by far the most important reinsurer of export credits and investments ("last resort"), in particular with regard to medium- and long-term risks. The operations which SID as the national export credit agency (ECA) performs on behalf of and for the account of the Republic of Slovenia are in terms of management and accounting clearly separated from the operations performed on the Bank's own account. Review of operations in 2006 Insurance against non-marketable risks on behalf of and for the account of the State 2002-2006 in EUR million 2002 2003 2004 2005 2006 business insured 748.8 806.6 810.0 388.7 402.2 exposure (31 Dec.) - gross* - net* 467.6 568.8 512.3 580.5 497.5 566.6 premiums 3.208 6.519 5.220 6.397 6.661 claims 0.504 0.415 2.124 3.242 0.994 number of claims 16 15 22 19 17 recoveries 0.514 0.044 0.174 0.067 0.081 * Exposure also considers offers of cover, given in accordance with ZZFMGP and with regard to their nature (binding). • Business insured Volume of business insured against non-marketable risks amounted to SIT 96.4 billion (EUR 402.2 million) in the year 2006, a 3% rise on the previous year. The increase was highest in medium-term export credit insurance, which climbed 22% to reach the highest annual level recoded to date (SIT 19.9 billion or EUR 83.2 million). However, the volume of insured investments of Slovene companies abroad, which takes up the largest share of total investments, dropped 2%. The downward trend was also apparent in short-term insurance (down by 10%) although its volume was too low to significantly affect the overall insurance volume. The number was down over 50% on the year 2004, mainly on account of the transfer of short-term revolving credits onto PKZ, a SID Bank subsidiary, and the recent changes in the reinsurance market reflected in better possibilities of providing reinsurance cover against commercial and non-commercial risks in higher-risk countries, which the private market had not been willing to assume prior to the beginning of 2005. 2005 namely saw a substantial year-on-year increase in the number of countries for which private reinsurers were willing to reinsure commercial and noncommercial risks and which are covered by PKZ (marketable risks). The correlation between insurance classes and their corresponding regional concentration became even closer in 2006. Medium-term export credit insurance centres around the CIS countries (88.9%), mostly Russia, Ukraine and Kazakhstan, whereas the countries of former Yugoslavia take up a the largest part of investment insurance. As for short-term risks, most insurance went to Iran, followed by Croatia and Argentina. There was, however, no record of insurance for the account of the state in other countries, mainly due to the mentioned transfer of portfolio to the SID subsidiary and the changes in the reinsurance market. The top 2006 investment insurance clients include Bosnia and Herzegovina, Serbia, Russia, Macedonia, Montenegro, Ukraine, Iran, Kazakhstan, Croatia, and Algeria. Exposure Exposure from business insured for the account of the Republic of Slovenia (insurance covers issued) stood at SIT 115.5 billion (EUR 482.1 million). The 13% rise over the 2005 figures resulted from increased medium-term insurance volumes (exposure medium-term insurance against commercial risks rose by 26%). Subject to the same trends mentioned above, medium-term insurance recorded the highest figures also in terms of exposure. There was an upturn in exposure from valid offers of insurance, rising by 16% to SIT 20.2 billion (EUR 84.4 million), which are counted in the total exposure on account of their binding nature and pursuant to ZZFMGP. Annual Report SID Bank - 2006 27 Exposure as at 31 December 2006 was largest with regard to the Russian Federation (29.04% of total exposure), Serbia, Bosnia & Herzegovina, Ukraine, Macedonia, Montenegro, Croatia, Kazakhstan, Belarus, and Iran. • Insurance technical figures Insurance premium rose 4.7% in 2006 to reach the highest level recorded in the company's history at SIT 1.6 billion (EUR 6.7 million). The growth in medium-term export credit insurance for which premiums are normally higher to account for longer credit maturity led to an increase in income generated from premiums. On the other hand, there was drop in premiums charged on investment insurance (down by 15%) and short-term export credit insurance. Income from handling fees was negligible because SID Bank, in conformity with its business policy, returns the amount charged to exporters and other persons insured if the project is implemented. Compared with 2005, claims paid were down 69% to SIT 238.1 million (EUR 1.0 million) in 2006, mainly because one large claim was paid in 2005 and in 2006 claims paid were relatively low in value and in number. The number of all claims paid was 17, most of them (16) arising from short-term credit insurance. The value of claims paid was highest with regard to export credit insurance for Croatia (53%), followed by Serbia, Montenegro, Bosnia and Herzegovina, Pakistan, Belarus, the Russian Federation and Macedonia. SID successfully recovered SIT 19.5 million (EUR 0.08 million) from paid claims, the relatively low amount being linked to a low number of claims paid out from insurance on account of the state in previous years. As at 31 December 2006, the volume of claims for compensation fell by 54% on the year 2005, and the volume of potential claims dropped by 12%. The current business result of insurance made for the account of the state was positive for the seventh year running, reaching the record at 1.3 billion (EUR 5.4 million), and was used up to further increase the contingency reserve, closing the year 2006 at SIT 23.4 billion (EUR 98.3 million). The cumulative business result rose to SIT 4.2 billion (EUR 17.6 million) for the first time in the 12-year history of SID operation. The trends and certain other explanations are presented in detail in subsections on insurance of traditional export credits (short-term and medium-term) and investment insurance. Business results by type of insurance against non-marketable risks are presented in the table below. Insurance against non-marketable risks on behalf of and for the account of the state, 2002 - 2006; by type of insurance in EUR million Short-term export credits 2002 2003 2004 2005 2006 Business insured 658.9 628.6 632.9 7.0 6.3 Exposure (31 Dec.) - gross* - net* 282.0 253.6 221.8 179.2 2.5 4.3 Premiums 1.596 2.073 1.666 0.267 0.050 Claims 0.426 0.369 2.116 0.743 0.467 Number of claims 14 15 22 18 16 Recoveries 0.048 0.078 0.116 0.067 0.081 Medium-term export credits Business insured 20.7 79.1 44.9 68.1 88.8 Exposure (31 Dec.) - gross* - net* 80.9 200.4 187.9 152.7 205.4 267.0 Premiums 1.132 3.586 2.449 4.036 4.824 Claims 0.078 0.046 0.008 2.499 0.527 Number of claims 2 / / 1 1 Recoveries 0.466 -0.034 0.058 / / Investments abroad Business insured 69.1 98.8 132.3 313.5 307.1 Exposure (31 Dec.) - gross* - net* 104.8 114.8 102.6 248.6 289.6 295.3 Premiums 0.480 0.860 1.105 2.094 1.787 Claims / / / / / Number of claims / / / / / Recoveries / / / / / * Exposure also considers offers of cover, given in accordance with ZZFMGP and with regard to their nature (binding). Short-term export credit insurance The major part of the total volume of short-term export credit insurance was linked to export credit revolving insurance of Slovene companies to buyers in Iran and Argentina, whereas there were also several individual export credit insurance covers for exports to Croatia (white goods and telecommunications equipment). The _ 28 Annual Report SID Bank - 2006 volume of short-term insurance (SIT 1.5 billion or EUR 6.3 million) was relatively modest. In 2006 the private market again started undertaking export credits to Argentinian buyers, which had a marked effect on the volume of insurance with regard to Argentina. Mainly as a result of newly extended credit limits to foreign buyers and several individual insured export credits which were still outstanding at the end of 2006, the year-on-year increase in exposure from these types of insurance was 69%, annual exposure reaching SIT 1.0 billion (EUR 4.2 million). Lower volume of business insured led to lower total insurance premium, which was down 81%, and a decrease of 37% in claims paid (SIT 126.3 million or EUR 0.5 million). Despite this reduction, claims paid exceeded insurance premiums in 2006. Thus, business result for short-term credit insurance on account of the state was negative. Medium term export credit insurance The majority of medium-term export credits insured in 2006 were linked to investment and construction projects abroad, hotel infrastructure, exports of turbines and other hydromechanical equipment, telecommunications equipment, rock wool production lines and other capital equipment, exports of agricultural mechanization and durable consumer goods to the Russian Federation, Ukraine, Kazakhstan, Iran, Croatia, Algeria, Romania, and Serbia. The volume of medium-term export credit insurance is fluctuating from year to year due to a low number of such projects executed on a yearly basis. In 2006 it totalled SIT 21.3 billion (EUR 88.8 million), recording an increase of 30.4% on the year before. In 2006 SID secured 26 medium-term export credits (compared with 24 in 2005) with a total of 11 main contractors or exporters and a significant number of Slovene subcontractors and subsuppliers. The main reason for a relatively low number of secured individual transactions requiring medium-term insurance and also financing lies in the low number of Slovene companies which are able to acquire such transactions on a regular rather than sporadic basis. The factors contributing to this situation include the development of banking systems in several traditional Slovene markets which are becoming increasingly capable of providing financing to their best companies at competitive financing conditions, less favourable insurance conditions for the markets of SE Europe resulting largely from unfavourable classification of these markets into risk categories and the facts that the financing options provided by Slovene banks are still less competitive than those provided by foreign banks. Exposure from the 75 currently outstanding transactions as at 31 December 2006 was SIT 50.1 billion (EUR 209.2 million), with the Russian Federation, recording a 67% share, as the predominating country of exposure. In 2006, total insurance premium amounted to SIT 1.2 billion (EUR 4.8 million), recording a 20% increase on the previous year. In that amount, reinsurance premium for active reinsurance accounted for SIT 431.3 million (EUR 1.8 million). One claim in the amount of SIT 126.3 million (EUR 527 thousand) was paid from insurance of medium-term export credit to Croatia. Investment insurance The increase in direct outward investment led to the relatively high volume of insurance against political risks, which amounted to SIT 73.6 billion (EUR 307.1 million) in 2006. Despite recording a 2% decrease on the year 2005, SID managed to retain its investment insurance centred on the area of SE Europe where the trust of investors is gradually picking up thanks to Euro-Atlantic alliances. In addition to investments insured SID Bank finished the year with four valid offers of cover totalling SIT 6.4 billion (EUR 26.6 million), which clearly shows that the trend of growing interest for outward investment insurance is likely to continue. The change in the attitude of several Slovene exporters to insuring investments of Slovene companies in foreign countries may be a result of completed transition and clearer ownership structure of Slovene companies, which sets high demands for investments to be insured. Besides, on the basis of experience gained from past events in the neighbouring countries and worldwide, Slovene exporters have realized that political risks were present everywhere and at all times. In 2006 SID Bank added six new transactions to its 28 valid investment insurance and shareholders' loan policies (two transactions in Croatia - manufacturing; one transaction in Serbia - hotel industry; one transaction in Iran -manufacturing; two transactions in Bosnia & Herzegovina - finance) with a total insurance sum of SIT 11.0 billion (EUR 45.9 million), which accounts for 14.1% of all investments insured at the end of 2006. In addition, SID Bank concluded an agreement to insure all current and future investments with two leading Slovene investment companies, and is currently negotiating conclusion of such an agreement with several other enterprises. At the end of 2006, the company portfolio included 34 investment insurance transactions of Slovene companies and banks worth SIT 64.4 billion (EUR 268.7 million), and together with its offers of cover SID gross exposure in investment insurance as at 31 December 2006 rose to SIT 70.8 billion (EUR 295.3 million). Investment insurance mainly covers transactions in Serbia, Bosnia & Herzegovina, Macedonia, Montenegro, Croatia, Germany, Iran _ 29 Annual Report SID Bank - 2006 and Belarus. In 2006, total premium was SIT 428.3 million (EUR 1.8 million), which is 15% less than in the year before; no claims were paid in that year. The decrease is total premium is largely due to the general downward trend of premiums rates in investment insurance. New developments concerning insurance on behalf of and for the account of the state The main change affecting insurance products and insurable risks in 2006 refers to the introduction of project financing insurance as the most complex type of insurance. With this product, SID Bank has rounded up its range of basic insurance products and services, only provided by several most developed foreign export credit agencies. Also important was the introduction of execution risk insurance for exporters, which had previously been covered by banks in credits to foreign buyers. In this way, SID Bank has improved its insurance conditions and reduced the conditionality of insurance covers, which will help the Bank to retain the first-class quality of the instrument in accordance with the Basel II Accord and provide exporters with easier access to funding for their export transactions. Furthermore, SID Bank introduced a new price list for covering pre-shipment risks, which enables Slovene exporters to obtain cover for manufacturing costs in the period prior to delivery at significantly lower premium rates. The Bank's revised export credit insurance rates allow for up 100 percent coverage of insurance premium financing, more flexible calculation of premium rates for export credits of over two years to developed countries and additional discounts in cases of additional quality guarantees. In the course of reorganisation conducted in mid-2006, aimed at simplifying access to and ensuring quality treatment of Slovene exporters and investors, Export Credit Insurance Department and Investment Insurance Department were joined into a common division. It is of particular importance that export credit insurance and investment insurance will retain their role in the new organisation structure of SID Bank and by 2010 enrich the range of products and services with a number of new products in line with the new SID Bank Action Strategy. New products which SID Bank intends to offer its clients in the future include export credit reinsurance against non-marketable risks, which will provide private credit insurers with additional possibilities and capacity in monitoring their export-oriented clients. At the end of 2006, the International Trade Promotion Commission gave its consent and SID Bank will, in accordance with the recommendations of the European Commisison, attempt to adjust this type of reinsurance to the needs of SMEs in Slovenia. Annual Report SID Bank - 2006 30 6.6. Operations on Special Authorisation - Interest Rate Equalization Programme (IREP) In accordance with the Act Governing Insurance and Financing of International Business Transactions (ZZFMGP), and on behalf of and for the account of the Republic of Slovenia, SID Bank implements the Interest Rate Equalization Programme for export credits in euros and American dollars, which will be in compliance with the OECD Arrangement on Officially Supported Export Credits. In November 2006 SID and the Ministry of Finance concluded an Agreement on Implementation of the Interest Rate Equalization Programme. SID Bank will coordinate the dynamics of interest rate equalizations with budgetary means as well as concrete calculations and granting of credits by SID Bank and other financial institutions that provide funding for the exports of Slovene goods and services. The primary objective of the Interest Rate Equalization Programme is to provide export credits at fixed interest rates which are lower than the commercial interest rates. SID Bank enters into interest rate swaps with participating banks, thus providing them with fixed interest rate finance. The purpose of interest rate swaps is to reduce exposure of the participating bank to interest rate fluctuations originating from approvals of fixed-rate export credits. Since the participating bank is limited with regard to the final margin, it is entitled to the application of an equalization factor. For end borrowers (foreign buyers of Slovene goods or services) the interest rate is not lower than the CIRR interest rate, and its maximum is also set. More favourable financing will improve the competitiveness of Slovene exporters in foreign markets. The interest rate risks linked to IREP are covered by SID Bank through inverse interest rate swaps into which the Bank will enter with foreign banks not rated lower than BBB- by Standard & Poor's. Annual Report SID Bank - 2006 31 6.7. Credit Rating and Other Credit Information Enterprises and financial institutions operate in a highly competitive, dynamic, rapidly changing and uncertain environment, which requires them to be well-informed and to respond quickly and adequately to the ever-changing situation on the market in order to carry out effective risk management. Aware of these requirements, SID continued to develop its own Credit Rating Department also in 2006. In its work, the department uses state-of-the-art professional methodology of risk assessment, in particular with regard to solvency, an internal information system, existing and regularly updated internal databases, reliable credit information and analyses of domestic and foreign institutions, as well as other data, which is also exchanged, for example among the members of the Berne Union. In assessing country risks of foreign markets SID works closely with other relevant institutions, in particular with the Centre for International Co-operation and Development, which provides basic country risk reports for selected markets. In support of internal needs of SID Bank, the Credit Rating Department prepares credit rating reports and credit information on domestic and foreign companies and banks. With a view to ensuring efficient credit risk management in financing, issuing guarantees and in certain classes of insurance and for external users of credit information, the department prepares corporate credit rating reports which also include the recommended credit and exposure limits. Additionally, SID Bank provides such information to other domestic and foreign financial institutions whose interest in credit rating information is increasing, in particular as regards information on selected markets, companies and banks in Slovenia and in those countries of South Eastern Europe that represent traditional Slovene markets. The companies of the SID Bank Group and external clients can order with SID Credit Rating Department: • credit rating information on Slovene companies (including sole proprietors), • credit rating information on Slovene banks, • credit rating information on banks and companies of SE Europe, etc. Access to credit information via the Internet Standardized credit rating information on Slovene companies (SID-BON) prepared by the SID Bank Credit Rating Department on the basis of publicly available data, is now readily available to registered users also via the Internet (SID-NET). Registered users are thus provided with a fast and safe (password protected) access to quality and up-to-date information, in particular with regard to Slovene companies, which enables SID Bank Group clients faster decision-making relative to business operations, risk monitoring and, consequently, better performance. Annual Report SID Bank - 2006 32 6.8. Risk Management Management and mitigation of risk and approach to risk aligned with corporate business objectives is one of the main challenges of every bank or other financial institution. In its risk management practises SID Bank needs to observe the specifics of the public character of the bank and the breakdown of its business operations into transactions involving the Bank's own assets, promotion of international business transactions financed with the guarantee of the Republic of Slovenia and activities performed for the account of the state, including the management of contingent reserves. The primary objective of risk management is to reduce the likelihood of a loss event and minimise losses when a loss event does occur. Risk management is a permanent process concerned with identifying, measuring, controlling and minimising risks, which is aimed at ensuring safe and stable operation of a company. Safe and efficient operation of the company is paramount in risk management, as in the long term it leads to increased equity value, helps the company enhance its reputation and maximises the benefits for SID Bank clients and other stakeholders. Risk management is a permanent process which comprises identification and measurement of risk and risk mitigation measures, aligned with the Bank's long-term strategy to create the conditions for safe and efficient operation of SID Bank. The precondition for efficient risk management is an appropriate organisation structure and regulated work processes, which enable achievement of business goals accompanied by implementation of safe business operations in compliance with the existing regulations. The key objective of risk management measures is to ensure high risk awareness at all levels of operation. Identification of risks is performed in organisational units which are separated from commercial units up to the level of the Management Board so as to provide for their independent and objective operation. The responsibility for direct implementation of risk management lies with the following bodies and organisational units: • Credit Risk Committee; mitigation of credit risk and large exposures, • Liquidity Risk Committee; liquidity and currency risks, • Asset-Liability Committee; balance sheet composition, capital adequacy, aggregate risk, • Risk Management Department; preparation of risk management policies, risk monitoring, • Credit Rating Department; evaluations of the credit risk of investments, • Back Office and Payments; daily follow-up on currency and liquidity risks within the set limits. SID Bank saw the key challenge and motivation with regard to risk management in the adaptation of Bank's operations with banking regulations. The process began in 2005 and was completed in 2006 when SID Bank acquired a banking licence from the Bank of Slovenia for performance of banking services. For SID Bank, harmonization with banking regulations is a stepping stone on the path towards complying with more demanding regulatory requirements provided for in the New Banking Act based on the Basel II Accord. The activities aimed at adapting the Bank's operations to the new regulations coincided with harmonisation to the existing legislation, and have intensified after SID Bank acquired its banking licence. Like most Slovene banks, SID Bank has postponed the application of new regulations by the beginning of the year 2008, wherever the Banking Act allows for such a delay (calculation of capital requirements for credit and operational risks, certain provisions concerning regulatory oversight). The principal risks faced by SID Bank are credit risk, currency risk, interest rate risk and operational risk. Risk management is of particular importance in credit and investment insurance as these operations are conducted on the behalf and for the account of the Republic of Slovenia. Loss ratio is compensated from the contingency reserve, but higher losses from these operations could bring contingent funds down to a level for which ZZFMGP provides for special means allocated from the budget of the Republic of Slovenia. Effective risk management starts with a proper organisation structure. Credit and investment insurance is conducted by a special department which is separated from banking operations to the level of the Management Board. Definition of the right to close deals is similar to the banking segment, in that all deals in the amount exceeding five million euros can only be approved by the International Trade Promotion Commission. The Commission holds ultimate authority over other risk management issues such as approving insurance policies for certain countries or groups of countries, which limit the potential volume of loss in addition to the insurance limits specified in ZZFMGP. Capital and capital adequacy Adequate capital is key to ensuring the solvency of financial institutions. Capital adequacy, expressed in relative terms with regard to the volume of business and the undertaken risks, guarantees trust in the company's operations and enables a stable development of the company in line with its set goals. Annual Report SID Bank - 2006 33 SID regulatory capital, calculated according to the Regulation of the Bank of Slovenia on Capital Adequacy of Banks and Savings Banks which covers all SID operations on own account (except for insurance of international business transactions, management of contingency reserves and IREP), amounted to SIT 16.0 billion (EUR 66.8 million) as at 31 December 2006, a drop of SIT 1.9 billion (EUR 7.8 million) on the year 2005. The Bank must take the differences between the impairments and provisions declared under collective assessment method under the IFRS methodology and the amount of impairments and provisions calculated on the basis of the percentages specified in the Regulation of the Bank of Slovenia on the Assessment of Credit Risk Losses of Banks and Savings Banks into consideration as a deduction item in the calculation of regulatory capital in accordance with the current regulation on capital adequacy of banks and savings banks. The relatively high decrease of company's capital was largely the result of the portfolio of loans to banks, for which impairments and provisions are calculated under the Bank's own methodology (for more detailed information on the policy of impairment and provisions formation see 6.2.5 Notes to the Financial Statements). Capital adequacy ratio is the ratio between the company's regulatory capital and risk-weighted assets of credit and currency risks. The minimum ratio of 8% was significantly exceeded in 2006. In consideration of the operations governed by the Banking Act, the capital adequacy ratio was 109.7%, and 20.7% considering all the operations SID conducted in the year ending for its own account (all operations except insurance of international business transactions, management of contingency reserves and IREP). Similar capital adequacy figures were obtained in calculations under the Basel II Accord, which the Bank will start implementing in 2008. Credit risk Credit risk is the risk of financial loss from a counterparty's failure to settle financial obligations as they fall due. Credit risk management begins prior to conclusion of a contractual relation by determining the credit rating of a client and by putting in place appropriate insurance instruments. The credit exposure limit is approved by the Credit Risk Committee. Throughout the transaction life cycle, credit risk is managed through close monitoring and credit portfolio management, by limiting the concentration of credit risk with regard to a client, a group of clients, a sector and a country, by classifying and creating provisions for expected losses and by providing sufficient capital for incidents when the actual losses exceed expectations. Credit risk considers: • risk of financial loss from credit transactions, • country risk, • risk of securities issuer, • credit risk of counterparty default and derivative financial instruments. Pursuant to the Regulation of the Bank of Slovenia on the Assessment of Credit Risk Losses and in consideration of the credit rating of a client and other elements of performance capability and quality of insurance, exposure from credit transactions, credit compensation value of derivative financial instruments and other types of exposure, which are classified according to credit quality and for which losses are assessed, are divided into five categories with the clients of the highest credit rating ranked A and the clients of the lowest credit rating ranked E. This classification is consistent with the Regulation of the Bank of Slovenia on the Assessment of Credit Risk Losses and is used to measure the change in credit quality of a financial asset (transitions between categories) and to assess aggregate credit quality. SID credit portfolio by credit rating category as at 31 December 2006: Category in SIT million in EUR million Share A 175,807 733.6 78.7% B 45,995 191.9 20.6% C 0 0.0 0.0% D 1,544 6.4 0.7% E 44 0.2 0.0% Total 223,391 932.2 100.0% The balance of SID Bank credit portfolio as at 31 December 2006 indicates that 79% of all credits, other claims and off-balance sheet liabilities are classified into the highest credit rating category. A further 21% of the portfolio fall into the B credit rating category, whereas the categories C, D and E account for a total of less than 1%. Impairments and provisions are an important element of mitigating the risk of loss arising from a credit event (Impairment and provisioning policies are presented in more detail in 6.2.5 Notes to Financial Statements). As at 31 December 2006 SID Bank recorded impairment and provisions totalling SIT 3.4 billion (EUR 14.0 million), which is SIT 285.0 million (EUR 1.2 million) more than a year before, based on data prepared under IFRS. Impairment and provisions are derived from losses assessed individually or on the group basis, whereas losses arising from credit exposure classified in credit quality categories C, D or E are assessed individually. The ratio of total provisions and impairment and total exposure classified into all categories is 1.85%. Annual Report SID Bank - 2006 34 Additional credit risk which occurs in cases when the debtor is from another country classified into higher country risk category is mitigated by SID Bank with additional provisions and impairment and higher collateral requirements. A large portion of exposure, 92%, refers to debtors from Slovenia, and the remaining 8% mostly concerns debtors from the countries of former Yugoslavia and Russia. SID credit portfolio by debtor's country as at 31 December 2006: Country in SIT million in EUR million Share Slovenia 205,651 858.2 92.1% Croatia 6,024 25.1 2.7% Russia 4,594 19.2 2.1% Other countries 7,098 29.6 3.2% Total 223,391 932.2 100.0% Issuer risk is linked to the portfolio SID manages with a view to ensuring liquidity and asset-liability management. SID does not conduct trading transactions. The Bank mitigates credit risk by setting limits as to the credit rating of the issuer and by monitoring market values of securities concerned. Securities portfolio by credit rating of issuer as at 31 December 2006: Credit rating (S&P) in SIT million in EUR million Share AA or higher 6,048 25.2 71.3% BBB- to A+ 1,390 5.8 16.4% Slovene banks, unrated 894 3.7 10.5% Other investments 155 0.6 1.8% Total 8,486 35.4 100.0% Liquidity risk Liquidity risk in the narrow sense is the risk which arises if SID Bank cannot cover its payment obligations with its liquid assets. Therefore, liquidity is the capacity of a company to hold and ensure sufficient resources to meet its (balance-sheet or off-balance-sheet) obligations when they come due. These obligations are normally settled from cash inflows, liquid assets and borrowed funds. The larger the mismatch of the principal and interest flows on the assets and the liabilities side and off-balance-sheet items, the larger liquidity risk. In accordance with the adopted Liquidity Policy Statement SID Bank ensured that all its financial obligations were regularly and continuously met. Liquidity management is based on planning the inflows and outflows, which SID performs separately for its own account and for the contingency account. SID monitors its exposure to liquidity risk by means of liquidity indicators (ratios between outflows and inflows over a month- and six-month periods), which the Bank of Slovenia sets at the minimum value of 1. Contrary to many banks, SID met these indicators for both domestic and foreign currencies. The value of indicators was normally over 2. High indicator values are a result of long maturity of liabilities and appropriate secondary liquidity. Liquidity risk in its broader sense, that is the risk of the bank having to take out funding at increased interest rate (funding risk) and the risk that due to its liquidity needs the bank will have to sell non-monetary investments at discounted value (market liquidity risk), is low thanks to excess short-term liquidity position and appropriate secondary liquidity. Secondary liquidity contains a relatively high proportion of government and other securities of high quality and liquidity. Currency risk Currency risk management is aimed at determining the potential loss that would arise as a result of changes in exchange rates, through application of an open foreign currency position, that is the difference between the sum of all investments in foreign currency and all liabilities in foreign currency. Investments and liabilities in foreign currency include positions in currencies and positions in tolars indexed by exchange rate. The open foreign currency position is limited through internal limits, separately for euro positions, for which a higher limit was approved due to a viable plan for the adoption of the euro, and for positions in other currencies with lower limits. Furthermore, in accordance with the Decision of the Bank of Slovenia on Capital Adequacy of Banks and Savings Banks, the higher value of the sum of long positions or the sum of short positions is included in the risk-adjusted positions which need to be capital covered up to 8%. Although positive trends in the growth of euro operations were maintained in 2006, foreign currency position was on the decline. At the end of the year, liabilities in euros (incl. liabilities indexed with euro exchange rate) exceeded investments by SIT 12,084 million (EUR 50.4 million), and US dollar investments recorded an excess over liabilities in the amount of SIT 875 million (3.7 million). Positions in other foreign currencies were negligible _ 35 Annual Report SID Bank - 2006 throughout the year and closed at the end of 2006. Capital requirements for foreign currency risks totalled SIT 59.4 million at the end of the year. Balance sheet by currency structure as at 31 December 2006 Assets Liabilities Gap in SIT in EUR as % of in SIT in EUR as % of in SIT in EUR as % of million million total assets million million total assets million million capital in SIT 32,216 134.4 16.7% 26,498 110.6 13.7% 5,717 23.9 35.7% in SIT with EUR clause 5,504 23.0 2.8% 0 0,0 0.0% 5,504 23.0 34.4% EUR 151,048 630.3 78.2% 163,132 680.7 84.4% -12,084 -50.4 -75.5% USD 4,496 18.8 2.3% 3,622 15.1 1.9% 875 3.7 5.5% other currencies 0 0.0 0.0% 12 0.1 0.0% -12 -0.1 -0.1% Total 193,264 806.5 100.0% 193,264 806.5 100.0% 0 0.0 0.0% * Note: Considered capital under the Regulation of the Bank of Slovenia on Capital Adequacy of Banks and Saving Banks A detailed presentation of balance sheet by currency structure as at 31 December 2006 is available under 6.9.2 Notes to Financial Statements. Balance sheet by maturity as at 31 December 2006 Assets Liabilities Gap Maturity class in SIT in EUR as % of in SIT in EUR as % of in SIT in EUR million million total assets million million total assets million million on deposit 421 1.8 0.2% 10 0.0 0.0% 411 1.7 up to 1 month 10,536 44.0 5.5% 1,121 4.7 0.6% 9,415 39.3 1 to 3 months 10,483 43.7 5.4% 781 3.3 0.4% 9,702 40.5 3 months to 1 year 28,575 119.2 14.8% 9,350 39.0 4.8% 19,225 80.2 1 to 5 years 75,123 313.5 38.9% 78,753 328.6 40.7% -3,630 -15.1 over 5 years 68,126 284.3 35.3% 103,249 430.9 53.4% -35,123 -146.6 Total 193,264 806.5 100.0% 193,264 806.5 100.0% 0 0.0 Detailed presentation of assets and liabilities as at 31 December 2006 by maturity is available in 6.9.1 Notes to Financial Statements. Interest rate risk Business operations of SID Bank are linked to two types of interest rate risks. The first risk type arises from the difference between the lending interest rate applied by SID Bank and the borrowing interest rate, or interest rate sensitivity to changes in general market interest rates. The second risk derives from the interest rate sensitivity to income from investments funded from SID Bank capital. SID Bank manages its exposure to interest rate risk by harmonising the methods of interest rate calculation on assets and liabilities. The highest share of assets and liabilities is represented by euro-denominated instruments with interest rates linked to Euribor, which only leaves residual risk arising from timing differences of repricing to the reference rate and incomplete coordination in selecting the reference interest rate (three- or six-month Euribor). In addition to coordinating its interest rate calculations, SID also applied, in a limited extent, financial derivative instruments as an additional tool of interest rate risk mitigation. The application of the fixed interest rate is limited in assets to short-term and medium-term credits and investments in securities, in the total amount of SIT 32.0 billion (EUR 133.4 million), only SIT 8.3 billion (EUR 34.7 million) with residual maturity of over 1 year. Fixed interest rate deposits are mostly short term, in the total amount of SIT 10.0 million (EUR 41.6 thousand). Annual Report SID Bank - 2006 36 Presentation of assets and investments by period remaining to interest rate repricing as at 31 December 2006 Assets Liabilities Gap Maturity class in SIT in EUR as % of in SIT in EUR as % of in SIT in EUR million million total million million total million million assets assets on deposit 958 4.0 0.5% 0 0.0 0.0% 958 4.0 up to 1 month 29,374 122.6 15.2% 31,655 132.1 16.4% -2,281 -9.5 1 to 3 months 60,791 253.7 31.5% 64,277 268.2 33.3% -3,486 -14.5 3 months to 1 year 93,259 389.2 48.3% 71,921 300.1 37.2% 21,338 89.0 1 to 2 years 3,162 13.2 1.6% 0 0.0 0.0% 3,162 13.2 2 to 5 years 1,252 5.2 0.6% 0 0.0 0.0% 1,252 5.2 over 5 years 4,468 18.6 2.3% 25,412 106.0 13.1% -20,944 -87.4 Total 193,264 806.5 100.0% 193,264 806.5 100.0% 0 0.0 Operational risk Operational risk refers to the operations of the company and depends on its internal organisation, operation of internal controls, effectiveness of internal and external audits and similar measures. The main factors of operational risk are human resources, business processes, information technology and other infrastructure, organisational structure and external events. In view of the relatively high balance sheet total, the operational risk per employee is quite high, but SID Bank manages to control it through a system of decision-making and authorisations, by providing substitutions for times of absence, through suitable staff qualifications and investments in information technology. System risks inherent in information technology are increasing in line with the level of informatization. They were managed through additional measures such as implementation of continuous operation plans and other measures aimed at maximising information security. Risk management in the SID Bank Group Consolidated risk management observes the heterogeneity of the Group consisting of a parent institution, authorised and supervised under banking regulations, subsidiary insurance companies, authorised and supervised under the Insurance Supervision Agency, a factoring company, which assumes risks similar to those undertaken by the Bank but is not regulated, and PRO KOLEKT as a non-financial institution which does not assume greater financial risks. In performance of their respective operations, business links have formed between these companies that affect the type and volume of consolidated risks. Special attention is paid to areas where the nature of transactions performed could lead to a concentration of the same risk, which is of particular relevance in concentrations of credit and insurance risks with regard to the same debtor (considering the links between risks/debtors). Furthermore, all companies have in place an appropriate organisation structure that enables effective risk management by defining risk assumption processes, identifying, measuring and managing risks. Annual Report SID Bank - 2006 37 6.9. Information System In 1995 SID embarked on a systematic development of its information system, which has since then been evolving as a document management system and as a system designed to facilitate communications of its users. To cope with the company's expansion of financing operations, monitoring of demanding credit operations and the process of obtaining a banking licence by the Bank of Slovenia, the information system of SID Bank has had to undergo several essential changes in its development and structure. The changes include implementation of additional control mechanisms and advanced transaction models, introduction and upgrade of security policy and preparation of new products. In 2006 IT focused on carrying out all the activities necessary to ensure higher quality of the information system, compliant with the requirements of banking operations and banking regulations. Software upgrade needed to support banking operations was successfully completed. At the beginning of 2006, SID Bank introduced two CREDES business software applications which support the credit, deposit and guarantee transactions, and a new general ledger, which were all integrated into an information system linked to a common data module (data on business partners, statistical data, codes, etc.). All systems use uniform standards and codes. An important activity carried out in 2006 that affected the entire SID Bank Group was the introduction of the euro in all IT applications. All activities in these fields were completed in time and efficiently. Following a request from the Bank of Slovenia, the hardware and software owned by SID subsidiaries PKZ and PRO KOLEKT were separated from the hardware and software owned by SID Bank. The quality, accessibility and availability of data were enhanced through separate development, test and production environments and through increased control of the system and application software and hardware installed (introduction of Systems Management Server to exercise control over the introduction of changes in the Windows environment). In introduction of new projects and realization of tasks (application development), SID Bank has adopted the project-based work method with all the corresponding work procedures and documentation. The IT Department worked intensively on the implementation of the security policy and regular updating of overall IT documentation in compliance with ISO 1779. Formation of an information protection committee has further improved internal control as well as transparency and oversight of the operation and development of the integral SID information system. In 2006 the operation of the information system was subject to several audits carried out both by the Bank of Slovenia (acquisition of the banking licence, changeover to the euro) and by independent certified auditors. The development of the company information system and information technology depends largely on the fundamental business strategy of the company, its future orientations and all the acts required either by various standards or external institutions. Evolution of the system of financing and export insurance and introduction of new SID Bank products and services have created the need for organisation changes, which in turn bring new challenges to efficient data management. In order to facilitate efficient management and decision-making processes, basic integration of data was ensured in 2006, and will remain one of essential IT tasks in the future. Introduction of new business activities will strengthen the need for construction and implementation of information support which will be based on new software and hardware technologies. In response to these needs, IT Department puts rationalization of business processes at the centre of its activities by increasing the information flow between various information sources. Annual Report SID Bank - 2006 38 6.10. Personnel Human resources policy With regard to education and development, SID Bank began implementing the key goals stated in the human resources policy, based on the SID Bank's strategy for the period 2006-2010: • to enhance employee identification with the new mission statement and strategy of the Bank, • to upgrade specialist knowledge and to develop and acquire specialist knowledge on new bank activities (also by hiring new staff), • to put in place»learning organization« and »knowledge management« models, and • to ensure innovative transfer of good practice. The Action Strategy as a set of basic principles of SID Bank operations defines the following values that the employees embrace and demonstrate in their daily work, relations with colleagues and contacts with customers and other interest groups: identification and satisfaction of the needs of customers and the environment, responsibility, openness and creativity, professionalism and teamwork, trust and transparency, and cooperation and sustainable development. Employee development Employee development was at the centre of attention also in 2006. Promoting employee development is one of the key conditions and elements of corporate development, as only a company with qualified and competent staff can be competitive in the global market. Annual appraisal interviews and semi-annual interviews to determine the achievement of set goals were conducted with all employees. Annual appraisal interviews are the basis for the assessment of an individual's development potential, identification of key personnel (managers and specialists - responsible for development of new activities) and preparation of an annual training plan, since they can point to the needs for new knowledge, facilitate targeted training and education for individuals and employee groups. A reward and recognition scheme has been designed to reward and motivate high-performing personnel and utilize their capabilities to achieve ambitious business plans. Training Considering the need for expert knowledge in the area of financing and insurance of business transactions, SID Bank gave special attention to acquiring and transferring knowledge, in particular in insurance, financing, treasury, legal matters, information technology, accounting and internal audit. Training took the form of in-house training and participation in conferences, workshops, seminars, postgraduate studies and the like, both in Slovenia and abroad. Employees also acquired certain general skills, especially with regard to foreign languages, computing, goal setting, time management, business etiquette, etc., and specific knowledge, e.g. key account management, corporate financial analyses, insurance of bank investments, business negotiations, project funding, integration of Slovenia into the European Union, international financial reporting standards, payment systems, public procurement, etc. In 2006 sixty-four employees (94.1% of all employees) attended various forms of training. The number of hours spent on training averaged at 48.71 per employee. Project work The year 2006 was marked by the project of transforming SID into a bank, which included over two thirds of all SID employees. In parallel with this key project, several other projects were underway, with the project of changeover to the euro as the most important one. Recruitment (structure and trends) Personnel recruitment in 2006 was conducted in accordance with the approved business policy and recruitment plan. In the year 2006, ten employees were engaged, all with university degrees, five of them were engaged as trainees. _ 39 Annual Report SID Bank - 2006 SID Bank ended the year with 68 employees (46 2006 totalling 65. Personnel structure by education level as at 31 December 2006 Master's/ 63% and 22 men) with the average number of employees in Personnel structure by age as at 31 December 2006 age 51-60 10% 31% Labour costs Payment of salaries and allowances complies with the provisions of existing legislation and the Collective Agreement of Banks and Savings Banks of Slovenia. In 2006 SID covered part of the premium for the voluntary supplementary pension insurance and the premiums for the voluntary supplementary health insurance for all employees. Absenteeism In accordance with the Internal Orders, SID applies flexible working time which allows effective time management fully adapted to the needs and requirements of work processes. In 2006 the number of working hours totalled 129,584, of which 11,888 hours were used as annual paid leave, 280 hours as special leave and 192 hours as study leave. Sick leave in 2006 averaged at 2.15%. Maternity leave was quite high, totalling 5.32%, which is a result of the high percentage of women employees in SID (67.65%). Trade union The majority of SID employees are members of the company trade union, which is part of the Trade Union of Banks and Savings Banks of Slovenia. With respect to the rights and obligations of the employees, SID fully complies with the provisions of the Collective Agreement for Banks and Savings Banks of Slovenia, and by means of an annual contribution of funds SID also makes possible the activities of the company trade union (sports and recreation activities, cultural and other events). Working environment SID shows a special concern for optimum working conditions. In accordance with the Occupational Health and Safety Act and the implemented Statement of Safety with Risk Assessment, SID organised training of employees for safe and healthy work and protection against fire risk and provided preventive and periodical medical examinations. Internal communication Internal exchange of information and communication is ensured through numerous well-established tools and applications, such as: e-mail, internal e-newsletter and access to a number of databases (e.g. memos on business meetings, minutes and decisions of corporate bodies, internal rules and regulations, expert library, descriptions of work procedures, proposals and ideas). Annual Report SID Bank - 2006 40 In 2006 we conducted a questionnaire on evaluating the work of superiors, in which special attention was given to the communications between superiors and colleagues, to information-sharing, task delegation, feedback, mutual relations, motivation, etc. The response from employees was very good as 80.5% of all employees filled out their questionnaires. The average mark given was 3.5, which shows that the employee satisfaction was 70% concerning the statements given in the questionnaire. In line with SID strategic goals, management skills will remain at the focus of company's attention. Annual Report SID Bank - 2006 41 6.11. Internal Audit In 2006 Internal Audit provided audit assurances and advisory services consistent with The International Standards for the Professional Practice of Internal Auditing, code of internal auditing principles, code of professional ethics of internal auditors and relevant provisions of the Banking Act. The primary objectives of internal audit operation in 2006 were: • to complete the supervision system of the future SID Bank with emphasis on the supervision of the internal control • system with planned further improvements, • to maximize the efficiency of risk management control, • to control the required implementation of internal and external regulations with emphasis on the implementation of • the recommendations made by the Bank of Slovenia, all with an aim to maximize the positive effects on the objectives stated in the current business policy of SID and the adopted SID Bank Action Strategy. Pursuant to the Banking Act, internal audit activities in 2006 involved the following: • monitoring and evaluation of the effectiveness of risk management systems and assistance in risk management matters, • reviews, evaluations and testing of the efficiency of internal control systems, • assessments of the reliability of the information system • assessments of the reliability and integrity of accounting records and financial statements, internal controls and accounting procedures, • verification of the completeness, reliability and timeliness of reporting in accordance with the regulations, • checking the compliance of SID actions with internal and external regulations, • oversight of implementation of recommendations made in 2006 by the Bank of Slovenia and auditor's recommendations. Internal audit reviews were focused on the following issues: • organisation changes caused by the company's transformation into a bank • transition to the International Financial Reporting Standards • introduction of new software solutions in analytical bookkeeping and the general ledger • changeover to the euro. Throughout 2006, internal audit conducted 27 reviews. The findings of each review were reported directly to the Management Board. All the recommendations made by the internal audit were adopted by the Management Board. Internal audit also prepared quarterly reports and an annual report on internal audit operations. All reports were discussed at the regular meetings of the Management Board and the Supervisory Board. In terms of organisation structure and human resources, internal audit closely follows the requirements of the Banking Act. Internal audit employs two people, namely the Director of Internal Audit, who is a certified auditor, and an internal auditor, who holds the professional title of auditor. Annual Report SID Bank - 2006 42 7. Review of SID Bank Group Operations in 2006 7.1. Financial review of SID Bank Group operations The consolidated statements of the SID Bank Group include PKZ according to the full consolidation method and the PRVI FAKTOR Group according to the proportional consolidation method. Owing to its insignificant impact on the financial position and business results of the SID Bank Group, the PRO KOLEKT Group is not included in the consolidation. Consolidated income statement 2006_2005 2006_2005 in SIT thousand in EUR thousand Net interest 2,500,406 2,250,914 10,436 9,393 Net income from insurance 1,174,030 998,198 4,900 4,165 Net non-interest income 1,058,249 997,065 4,417 4,161 Labour, general and administrative costs -2,201,026 -1,648,467 -9,186 -6,879 Depreciation -128,777 -112,737 -537 -470 Impairments and provisions -392,318 497,269 -1,637 2,075 - insurance technical provisions -418,228 -296,101 -1,746 -1,236 Pre-tax profit 2,010,564 2,982,242 8,391 12,445 Corporate income tax -354,567 -755,740 -1,480 -3,154 Net profit 1,655,997 2,226,502 6,911 9,291 In 2006 pre-tax profit of the SID Bank Group amounted to SIT 2.0 billion (EUR 8.4 million). Net interest totalled SIT 2.5 billion (EUR 10.5 million) in 2006, rising 11.1% on the previous year. Net income from insurance climbed 17.6% reaching SIT 1.2 billion (EUR 4.9 million). Non-interest income, made up mainly of fees and commissions from credits and guarantees, factoring and treasury transactions and income from reimbursement SID receives from the state subject to the Agreement on the regulation of mutual relationships concerning implementation of Chapter II of the Act Governing Insurance and Financing of International Business Transactions (ZZFMGP), amounted to SIT 497.3 million (EUR 2.1 million). Net non-interest income was SIT 1.1 billion (EUR 4.4 million) and remained at the 2005 level. In 2006 operating costs totalled SIT 2.3 billion (EUR 9.7 million), an increase of 32.3% from the prior year, mostly due to higher costs of labour related to an increase in employee numbers. In the structure of operating costs, labour costs accounted for 58.5%, cost of services 33.5%, depreciation 5.5% and cost of materials 2.4%. Operating costs relative to total assets lowered from 1.21% in 2005 to 1.19% in 2006. Consolidated balance sheet 31.12.2006 31.12.2005 31.12.2006 31.12.2005 in SIT thousand in EUR thousand Bank loans 187,072,639 130,675,661 780,640 545,446 Loans from non-banks 38,009 1,413,799 159 5,901 Liabilities from factoring 1,374,127 883,578 5,734 3,688 Provisions 5,178,676 4,193,488 21,610 17,504 - insurance technical provisions 4,390,556 3,259,194 18,321 13,604 Other liabilities 2,273,098 2,521,532 9,485 10,525 Capital 28,685,443 27,405,557 119,702 114,392 Total liabilities 224,621,992 167,093,615 937,331 697,457 Contingency reserve 24,611,935 22,311,917 102,704 93,131 IREP 350,003 0 1,461 0 Off-balance-sheet items 65,200,306 74,167,474 272,076 309,579 As at 31 December 2006, consolidated total assets of the SID Bank Group stood at SIT 224.6 billion (EUR 937.3 million), showing a year-on-year increase of 34.4%. Contingency reserves for insurance carried out on behalf of and for the account of the state (including the corresponding liabilities) rose by 10.3% in 2006 to SIT 24.6 billion (EUR 102.7 million). There was a 43.2% increase in bank loans, making up SIT 187.1 billion (EUR 780.7 million) or 83.3% of total liabilities. Strong growth in factoring transactions led to a considerable rise of 55.5% in liabilities from factoring, totalling SIT 1.4 billion (EUR 5.7 million) at the end of 2006. Annual Report SID Bank - 2006 43 Capital of the SID Bank Group stood at SIT 28.7 billion (EUR 119.7 million), recording an increase of 4.7% through generated net profit. Capital accounted for 12.8% of total liabilities, compared with 16.4% of total liabilities as at 31 December 2005. 31.12.2006 31.12.2005 31.12.2006 31.12.2005 in SIT thousand in EUR thousand Financial assets available for sale 13,089,117 10,791,202 54,620 45,043 Loans to banks 144,707,914 109,632,634 603,855 457,612 Loans to non-bank sectors 39,261,083 33,803,353 163,834 141,097 Receivables from factoring 22,220,711 9,223,835 92,725 38,501 Tangible fixed assets and intangible long-term assets 1,604,797 945,883 6,697 3,948 Long-term investments in equity SID Bank Group companies 6,892 2,100 29 9 Other receivables 3,731,478 2,694,608 15,571 11,247 - reinsurance contracts 3,415,410 2,469,257 14,252 10,307 Total assets 224,621,992 167,093,615 937,331 697,457 Investments from contingency reserve 24,611,935 22,311,917 102,704 93,131 Investments from IREP 350,003 0 1,461 0 In 2006 growth of total assets again resulted from intensive financing of international business transactions and a rise in factoring services. Loans to banks increased by 32.0% to SIT 144.7 billion (EUR 603.8 million). Loans to non-bank sector were up by 16.1% totalling SIT 39.3 billion (EUR 163.8 million). The year-on-year increase was highest in acquired receivables, rising 140.9% to SIT 22.2 billion (EUR 92.7 million): Key figures of SID Bank Group operations 2006 2005 Shares - number of shareholders 87 87 - number of shares 932,354 932,354 - par value of a share 10 10 - book value of a share (in SIT thousand) 30.69 28.34 Profitability: - interest margin 1.28% 1.54% - financial intermediation margin 1.82% 2.23% - return on assets before taxation 1.03% 2.05% - return on equity before taxation 7.17% 11.28% - return on equity after taxation 5.90% 8.43% Operating costs - operating costs / average assets 1.19% 1.21% Number of employees in SID Bank Group The figure includes all employees of the PRVI FAKTOR Group (76 as at 31 Dec 2006 and 47 as at 31 Dec 2005). 188 143 7.2. SID - Prva kreditna zavarovalnica d.d., Ljubljana In 2006 SID - Prva kreditna zavarovalnica d.d., Ljubljana (hereinafter PKZ) was successful in increasing significantly the volume of existing contracts and premiums and managed to acquire new insurance contracts. The company's second year of operation was a success in terms of financial results. The volume of short-term credit insurance contracts entered into by PKZ in 2006 was SIT 898.5 billion (EUR 3.75 billion), a 24% increase on the business volume generated in short-term export credit insurance in 2005. Gross premiums written reached SIT 2.7 billion (EUR 11.2 million), rising by 20% on the year 2005, which is largely due to the growth of business insured with existing clients (a result of higher GDP and exports growth) and new persons insured. Claims paid amounted to SIT 1.1 billion (EUR 4.8 million), accounting for 42.6% of premiums written (40.5% in 2005). However, at SIT 208 million (EUR 0.9 million), recoveries (paid to PKZ) accounted for 18% of the paid claims (15% in 2005). Insurance technical provisions increased SIT 127 million (EUR 0.5 million) year-on-year to reach SIT 4.1 billion (EUR 17.1 million). Owing to a change in the regulations governing the calculation of equalization provisions in _ 44 Annual Report SID Bank - 2006 2005, equalization provisions continue to decrease whereas other items of insurance technical provisions remain on the increase. Gross profit was SIT 637 million (EUR 2.7 million), equity as at 31 December 2006 stood at SIT 2.0 billion (EUR 8.4 million) and total assets amounted to SIT 6.9 billion (EUR 29.0 million). In 2007 PKZ will continue to provide domestic and export credit insurance against commercial and noncommercial risks. By monitoring sales of the insured in their respective domestic and foreign markets, by carefully checking their buyers and though prompt processing of claims PKZ will provide its customers with unparalleled support in their financial receivables risk management. In addition, the insurance company will continue to look for new clients and present its services through personal visits and presentations as well as by providing information over the phone, mail and via the Internet. The market penetration in the segment of credit insurance covered by PKZ has already exceeded the European average. That is why in 2007 PKZ will start implementation of active reinsurance transactions, as enabled by the change in legislation adopted in 2006. First arrangements have already been made with partners in Macedonia, Bosnia and Herzegovina and Serbia. Together with other companies of the SID Bank Group, PKZ will strive to secure its presence and growth in these and other South European markets. PKZ will continually study the market possibilities for new and upgraded credit insurance products and these will be the focus of its research and development activities. The existing information system will be upgraded to include several applications enabling additional analyses. PKZ will also continue developing its support system for on-line business with the insured (PKZ-Net). To ensure better efficiency of business operations with regard to contracts for excluded transactions, PKZ has transferred several activities onto SID Bank. In terms of ownership and business performance, the operations of PKZ remain an inseparable part of the SID Bank Group, which ensures that regardless of legal changes the synergy effects of complementary facilities will be maintained. 7.3. PRO KOLEKT Group In 2006 the business operations of PRO KOLEKT, Ljubljana were focused on ensuring further growth of business volumes and on developing a network of subsidiaries in the territory of former Yugoslavia. In three years of its operation, PRO KOLEKT managed to set up a network of debt collection agencies in 72 states. In 2006, the company acquired 537 collection claims with a total value of SIT 3.4 billion (EUR 14.5 million) and recovered SIT 527 million (EUR 2.2 million) of receivables, which was 33% more than in the previous year. Additionally, the company acquired several new foreign clients so that foreign clients account for 32% of the company's turnover. In the future, we expect a rise in the demand from foreign debt collection agencies, with whom PRO KOLEKT has already been doing business, and from members of the Berne Union. Its 2006 PRO KOLEKT, Ljubljana generated income in an amount of SIT 85.0 million (EUR 0.3 million), a 55% rise from the prior year. The company closed the financial year with a loss totalling SIT 4.0 million (EUR 16.9 thousand). PRO KOLEKT, Ljubljana intends to continue expansion of its activities in 2007. In accordance with the Action Plan on the Expansion of the PRO KOLEKT Group to the markets of South Eastern Europe, drawn up on the basis of guidelines stated in the Action Strategy of Slovenska izvozna družba d.d. or SID Bank for the period 2006-2010, PRO KOLEKT will start the procedures for establishment of subsidiaries in this area. 7.4. PRVI FAKTOR Group In 2005, the intensive growth of the PRVI FAKTOR Group continued. The company purchased SIT 119.9 billion (EUR 500.4 million) worth of accounts receivable, an increase of 136.7% on the year 2005. PRVI FAKTOR, Zagreb acquired SIT 51.8 billion (EUR 213.4 million) of receivables, PRVI FAKTOR, Ljubljana purchased SIT 44.1 billion (EUR 184.0 million) and PRVI FAKTOR, Belgrade purchased SIT 23.9 million (EUR 99.7 million) worth of accounts receivable. The PRVI FAKTOR subsidiaries in Zagreb and Belgrade contributed nearly 63% of the total Group turnover, and the share of subsidiaries in the consolidated business result is even higher. Business volume growth led to an increase in consolidated total assets which stood at SIT 51.8 billion (EUR 216.1 million) as at 31 December 2006, showing a year-on-year rise of 123.3%. In terms of balance sheet total, the largest company in the PRVI FAKTOR Group is PRVI FAKTOR, Zagreb whose balance sheet total came to SIT 24.3 billion (EUR 101.5 million). The growth in business volumes is also evident in business results. Net profit of the PRVI FAKTOR Group amounted to SIT 558.6 million (EUR 22.3 million), showing a rise of 173.1% on the prior year. The highest profit in _ 45 Annual Report SID Bank - 2006 the amount of SIT 302.2 million (EUR 1.3 million) was generated by PRVI FAKTOR, Belgrade, which was founded in the beginning of 2005. Total assets of PRVI FAKTOR, Ljubljana were SIT 16.8 billion (EUR 70.3 million) as at 31 December 2006, rising 47.3% on the year 2005. Net profit of the Group totalled SIT 44.2 million (EUR 0.2 million) in 2006, and was down 15% from the year 2005. The primary objectives of the PRVI FAKTOR Group are to ensure further growth of the company, strengthen its market position with existing clients and enter new markets. The Group plans to acquire accounts receivable in the amount of EUR 677 million in 2006 and generate pre-tax profit of EUR 2.4 million. In 2007 a PRVI FAKTOR subsidiary in Macedonia is expected to start operation, and PRVI FAKTOR, Sarajevo will operate at full capacity. Annual Report SID Bank - 2006 46 8. Appendices 8.1. Management Bodies of SID Bank as at 31 December 2006 General Meeting of Shareholders Simon Oblak, MSc. - Chairperson Metod Zaplotnik - Deputy Chairperson Supervisory Board • Dr. Andrej Bajuk - Chairperson, Minister of Finance Ministry of Finance • Helena Kamnar, MSc. - Deputy Chairperson University of Ljubljana • Gonzalo Caprirolo, MSc. Ministry of Finance • Dr. Božo Cerar Ministry of Foreign Affairs • Jožko Čuk, MSc. Chamber of Commerce and Industry • Dr. Andrej Kitanovski Ministry of Economy • Dr. Mojmir Mrak Faculty of Economics, University of Ljubljana International Trade Promotion Commission • Sabina Kolesa, MSc. - Chairperson Ministry of Economy • Janko Burgar, MSc. - Deputy Chairperson Ministry of Economy • Dr. Robert Kokalj Ministry of Foreign Affairs • Janez Kosak, MSc. Bank of Slovenia • Cveto Stantic, MSc. Chamber of Commerce and Industry • Stanislava Zadravec Caprirolo, MSc. Ministry of Finance Management Board • Marko Plahuta, President • Sibil Svilan, MSc., Member Since 1 January 2007 SID Bank has been managed by the Management Board in the following composition: • Sibil Svilan, MSc., President • Jožef Bradeško, Member • Marko Plahuta, Member Annual Report SID Bank - 2006 47 8.2. Organisation Chart of SID Bank as at 31 December 2006 LEGAL AND CLAIMS DEPARTMENT Barbara Bracko DEPARTMENT Erih Skocir PERSONNEL AND GENERAL AFFAIRS Vida Zabukovec Annual Report SID Bank - 2006 48 II. Financial statements of SID bank Contents Auditor's report 1. Balance sheet as at 31 December 2006 2. Income statement for 2006 3. Cash flow statement for 2006 4. Statement of changes in equity for 2006 5. Balance sheet profit 6. Notes to financial statements 7. Appendices Page Statement of the Management Board on financial statements of Slovenska izvozna in razvojna 50 banka, d.d., Ljubljana 51 5S 54 55 56 57 58 89 Annual Report SID Bank - 2006 49 Statement of the Management Board on financial statements of SID - Slovenska izvozna in razvojna banka, d.d., Ljubljana On 9 March 2007, the Management Board approved the financial statements of Slovenska izvozna in razvojna banka, d.d., Ljubljana for the year ended 31 December 2006. The financial statements have been compiled in accordance with the International Financial Reporting Standards as adopted by the EU. The accounting policies and calculation methods applied were the same as those used in the preparation of opening balances as at 1 January 2005. The Management Board is fully responsible for appropriate accounting, the adoption of adequate measures for protection of property and assets and confirms that the financial statements, together with notes, have been prepared on the basis of the assumptions of going concern and in line with the applicable legislation as well as the International Financial Reporting Standards as adopted by the EU. The Management Board of Scenska izvazna in fHVOjne banka,il rf Ljubljana member me moer pígSídtrrt Ljubljana, 9 March 2007 50 Annual Report SID Bank - 2006 DELO TTE REVIZIJA d.o o Dunajska cesta & 1000 Ljubijana Slovenija Tel: +186(0) 1 3072 30Ö Fax: +386 ¡0] 1 3072 9Q0 www.deloitla com/Stovenla INDEPENDENT AUDITORS' RETORT Tu (he Shareholders of Slovenska razvojna in izvozna banka,